Working Paper: NBER ID: w23795
Authors: Joseph E. Stiglitz
Abstract: This paper provides a critique of the DSGE models that have come to dominate macroeconomics during the past quarter-century. It argues that at the heart of the failure were the wrong microfoundations, which failed to incorporate key aspects of economic behavior, e.g. incorporating insights from information economics and behavioral economics. Inadequate modelling of the financial sector meant they were ill-suited for predicting or responding to a financial crisis; and a reliance on representative agent models meant they were ill-suited for analysing either the role of distribution in fluctuations and crises or the consequences of fluctuations on inequality. The paper proposes alternative benchmark models that may be more useful both in understanding deep downturns and responding to them.
Keywords: DSGE models; macroeconomics; financial crisis; behavioral economics; information economics
JEL Codes: A1; A2; E0; E1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| DSGE model assumptions (E13) | predictive failures (C53) |
| financial frictions and credit constraints (E44) | amplification of economic shocks (F69) |
| inadequate representation of financial sector (G29) | misinterpretation of economic shocks (E32) |
| credit rationing (G21) | persistent economic downturns (E32) |
| DSGE models (E13) | incomplete understanding of economic crises (G01) |