Sunday, September 17, 2017

Brian Romanchuk — DSGE Wars (Again)

Although this sounds extremely harsh, it is the only way to describe aspects of DSGE macro such as the assumption that the level of interest rates is a key determinant of economic behaviour. In practice, this assumption is built into all mainstream models, and the empirical methodologies have no way of rejecting the assumption. It is not entirely an accident that the consensus has been shocked by the slow pace of recovery after modern recessions -- after all, it was believed that the level of interest rates was "unsustainably low." Indeed, the natural rate of interest had to be revised lower in order for the data to fit the theory.
In other words, the whole panoply of mathematics used is a gigantic red herring.

From the perspective of wanting to understand how the economy functions, there is only one real question: are the desired theoretical outcomes of DSGE macro practitioners useful? The fact that DSGE macro is roundly ignored by everyone whose job depends upon being right about the economy is probably the best answer to that question. (In theory, central bankers are supposed to care about being right about the economy, but in practice, even the raw incompetence displayed heading into 2007 did not cut into retired senior central bankers' subsequent speaking fees.)

From the perspective of academic economics, it is an obvious problem that this methodology has to be used in the "top journals." This is only a surprise if you assume that the academic system shows a tendency to progress towards the truth.…
Fitting the world to a model doesn't work so well.

The key criticsm from the POV of logical analysis and philosophy of science is this:
In Section 7.3, recursive competitive equilibrium is defined. It starts with a lot of mathematics, but even then, some economist hand-waving sneaks into the definition. They use terms that do not appear to correspond to standard mathematical concepts, and hope the reader knows what they mean. Mathematics largely consists of statements about sets and the property of sets; it is unclear what set properties they are describing at key sections of their definition.
Math may look impressive but it says nothing that is not contained in the stipulations — definitions and axioms that relate them. In represesntational models these stipulation establish the semantic connection with the "world" that the model purports to represent. That world provides the objective criteria for assessing the how representative a model actually is in application.

Problems at this foundational level result in GIGO. There is no room for lack of specificty in mathematical reasoning.

Bond Economics
DSGE Wars (Again)
Brian Romanchuk

4 comments:

Matt Franko said...

Control Theory requires designation of a Setpoint....

Where is their Setpoint in DSGE?

They don't have one....

https://en.m.wikipedia.org/wiki/Setpoint_(control_system)

MMT: "Set unemployment rate to zero....". "Set number of people without access to healthcare to zero.....". Etc....

NeilW said...

Maths in macro-economics is the modern form of the Latin Mass. It is there to make the priest sound sophisticated and give them credence power. It serves no other communication function with normal people. It's entirely a power statement.

Matt Franko said...

They are the C students Neil....

AXEC / E.K-H said...

The new macroeconomic paradigm
Comment on Brian Romanchuk on ‘DSGE Wars (Again)’

(i) Every economist knows by now that DSGE is a failed approach. Strictly speaking, the microfoundations approach has already been dead in cradle 140+ years ago.

(ii) The microfoundations approach is defined by this axiom set: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states. (Weintraub) Fact is that every model that contains just one of the axioms is false.

(iii) Because the microfoundations approach is axiomatically false a paradigm shift is imperative. Methodologically it holds: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle) The paradigm shift consists of the replacement of false premises, i.e. microfoundations, by true premises, i.e. macrofoundations.#1

(iv) This is the correct core of macroeconomic premises:#2
(A0) The objectively given and most elementary systemic configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

These premises are certain, true, and primary, and therefore satisfy all methodological requirements. The set of premises is MINIMALISTIC, that is, it cannot be reduced further, only expanded. The graphical representation of the pure production-consumption economy is given on Wikimedia.#3, #4

(v) The condition of market clearing is X=O and of budget balancing C=Yw. From non-clearing and non-balancing follow the phenomena of inventory changes (O-X greater than 0 or less than 0) and of monetary saving/dissaving (Sm≡Yw-C greater than 0 or less than 0) and of monetary profit/loss (Qm≡C-Yw greater than 0 or less than 0). It always holds Qm+Sm=0 or Qm=-Sm, in other words, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law.#5

(vi) Given the minimalist core propositions (A0) to (A3) one has to proceed top-down by successive DIFFERENTIATION until one arrives at the individual agent. Differentiation is the opposite of bottom-up or aggregation. The bottom-up = microfoundations approach has always been methodologically indefensible because it runs with necessity into the Fallacy of Composition.

(vii) Note that the macro axioms are composed of measurable variables. This is the precondition for testing the derived complex relationships = economic laws.

(viii) The correct systemic macrofoundations FULLY replace the false Walrasian microfoundations and the false Keynesian macrofoundations. There can be NO pluralism of axiom sets. For ALL economic research, the macroeconomic premises (A0) to (A3) are ABSOLUTELY necessary. It holds: If it isn’t macro-axiomatized, it isn’t economics.

Egmont Kakarot-Handtke

#1 Keynes’s macrofoundations are false, see ‘How Keynes got macro wrong and Allais got it right’
https://axecorg.blogspot.de/2016/09/how-keynes-got-macro-wrong-and-allais.html

#2 For the complete set of macro axioms see Wikimedia
https://commons.wikimedia.org/wiki/File:AXEC88.png

#3 Wikimedia: The pure production-consumption economy
https://commons.wikimedia.org/wiki/File:AXEC31.png

#4 True macrofoundations: the reset of economics
http://axecorg.blogspot.de/2017/05/true-macrofoundations-reset-of-economics.html

#5 From the macro axiom set follow the Four Basic Economic Laws
https://commons.wikimedia.org/wiki/File:AXEC107.png