Dynamic stochastic general equilibrium modeling or DSGE is one of the branches in general equilibrium theory that is of vital importance to macroeconomics. Macroeconomics deals with studying of growth and fluctuations of the extensive national aggregates, which are inclusive of such elements like employment levels, national income, price levels among other factors that are vital to a country’s standards of living. Criticisms arose because this theory was not able to predict the financial crisis that occurred in 2007-2010. The financial crisis led to various economic problems, and the adverse effects were felt the world over (Bateman 37).
Robert Solow criticized the DSGE model since it failed to foresee the crisis. He commented that the theory viewed the economy as a single, consistent being that carried out a pre-determined plan that was a long term in nature. Thus, whenever problems occurred in the economy, the DSGE adapted to bring the situation back to equilibrium and correct the problems. He furthermore added that those who were concurring with the model did so on a profound and a baseless idea. Those with the idea tend to believe what they say but forget to question the essence of their beliefs. Macroeconomics was looked upon to explain and help in finding an effective solution to the recession. Specifically, the DSGE model seemed like the perfect antidote to the situation. Despite all that, it still did not offer a solution despite the fact that it was applied in scholar thinking within universities, in central banks and also influenced policy formation (Caballero 45).
The basic agents of economics, for instance consumers, investors, borrowers, lenders, workers and employers make their own decisions for the good of their individual preferences. Despite this, their decisions are not always realistic, and variances can be realized in their decisions. Furthermore, the DSGE school of thought tries to populate its simplified economies, with a singular combination of various elements like worker-owner-consumer-everything else who predetermines their intentions and succeed in the long term. The biggest assumption to this reasoning is that there are no-existent conflicts of interests, incompatible expectations or dishonesty. Thus, the economy is run by these singular agents, even though not directly. The economy still has its own internal controls, for instance markets and prices. Because of pressure from individuals who were dissatisfied with the model and the realization of the need to deal with the reality, DSGE modelers have included various market flaws like asymmetries of information. Besides all these efforts, the model still treats the economy based on singular forces. Thus, the model will not have a fruitful solution to the recession witnessed since the solutions are based on assumptions that a macroeconomic policy would help to remedy (Allen 13).
Kirman, another economist who criticized the DSGE model, also had his views. He explains why the model has difficulties in trying to explain the current economic crisis. It is worth noting that the current economic crisis was considered deeply in order to look if there existed a relationship between it and the standard economic theories. If the economic crisis and the economic theories cannot relate to each other then the theories would have to be done away with or changes made to them.
Warnings about the unrealistic nature of financial models and problems related to the underlying General Equilibrium theory have been exhibited throughout the years, but they have not been considered. Thus, these models have continued to be applied to economic policies, yet they are not applicable theoretically. Thus, Kirman is keen to suggest that the individual basis is dropped which entails aggregate behavior. Furthermore, the irrational idea that individuals behave in a reasonable manner should be dropped. Therefore, the economy should be assessed as a complicated system that has its own adaptive methods. The structures within the economy that guide it should also be considered. Thus, the models applied would be able to realize the predictive nature that economic models should be characterized with (Caballero 56).
DSGE models presently cannot be applicable to economic problems afflicting the world. In instances of policymaking, this model is a crucial factor when it comes to approximations. Furthermore, this model has flaws within it since it lacks formal literature on how it should be applied thus is not to be used as a favorable basis during formulation of public policy. It would not be easily to apply it since it lacks a firm and constant basis that guides it. Thus, it would help to find the best ways and means applicable that this policy can be applied effectively. Since the DSGE if far from ideal, experimentation with the intended purpose is not always put into consideration. Comparisons of the economic model can be made with Toxicology, a branch in Biology. In toxicology, there exists detailed literature about acceptable techniques and practices for creating policies to be applied to humans based on conclusions obtained from experimentations with rats. Therefore, the rat model is a dynamic general equilibrium system that is fully micro founded. The results obtained from experimentations are close to the results realized in reality.
In conclusion, the macroeconomic theory (specifically the DSGE model) has been criticized by various economists as they have seen the weaknesses that are characteristics of this model. It is also their opinion that economic problems are still experienced even with the fact that the DSGE has failed to explain these problems.
Works Cited
Allen, Fade, and Daniel, Gale. Understanding Financial Crises, Oxford University Press,
Oxford, 2007. Print.
Bateman, Bernard. The return to Keynes. Massachusetts: Harvard University Press, 2010.
Print.
Caballero, Right. “Macroeconomics after the Crisis: Time to Deal with the Pretense-of
Knowledge Syndrome.” Journal of Economic Perspectives 24 (4): 85–102, 2010.
