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Equilibrium Models of Macroeconomic Science: What to Look For in (DSGE) Models?

Chatterjee, Sidharta (2014): Equilibrium Models of Macroeconomic Science: What to Look For in (DSGE) Models?

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Abstract

Models in macroeconomic sciences are designed with the aim of understanding and then simulating the real world economic and monetary policy making. There has been a considerable debate over how to model the real world economic phenomena, and how correctly those models allow explanations of general equilibrium; that is, whether the models with their assumed parameters are able to expound on critical aspects of monetary policy making. Some models are structured to provide naïve explanations of the monetary policy process, while others are higher order complex models that attempt to elucidate the dynamicity of economic equilibrium. Dynamic Stochastic General Equilibrium (DSGE) model is one of such a complex model which has found the flavour of the time following its rapid adoption by Central Banks around the world. But strong contentions rebate the usefulness and question its effectiveness over other standard tools of macroeconomic and monetary policymaking process. Many scholars debate that DSGE models are far from perfect, to render it efficient in public policy making, although its adoption has been one such phenomenal. This paper aims to discuss in some detail about such debates relating to the contentious issues which arose on account of the failure of DSGE models to effectively detect the recent financial crisis the subprime of 2008. Hence, the present study revolves around a formal analysis of the epistemology of econometric modeling involving complex dynamic systems in real world policy making, and discusses whether if new models like DSGE could in fact help explain general equilibrium, or if they fail, then what to look for in their failure.

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