In Which I Try to Answer a Question asked by Larry Summers as a Joke
The LSE held a discussion on Reconstructing Macroeconomics. Brad DeLong posted a transcript , the video is here.
Larry Summers opened with a joke
Larry Summers: You know I was tempted to blast off at Dynamic-Stochastic General-Equilibrium models. That is, actually, my inclination. But on the other hand it occurred to me to ask the question: “What wouldn't be a Dynamic-Stochastic General-Equilibrium model?” That would be a Static-Certain Partial-Equilibrium model. It is hard to see how that represent any kind of an improvement. So I can't be against DSGE on principle.
I have a sense of humor, but I am going to suppress it and pretend to take the joking answer literally. I note that the diametric opposite of a Dynamic-Stochastic General-Equilibrium model would be a Static-Certain Partial-Disequilibrium model. Even in jest, even Summers has trouble separating the concepts of model and equilibrium — which in context means Nash equilibrium. Also the joke is a joke, a Dynamic-stochastic-partial equilibrium model is not a Dynamic-Stochastic General-Equilibrium model.
It is also easy to answer the question, because there are models older than any DSGE model — Summers can propose we go back to using those models. For one thing, he clearly does use those models (as do DeLong and Krugman). They weren't equilibrium models.
Bernanke and Blanchard (who have made huge contributions to Reconstructing Macroeconomics) assume in their answers that they are required to start with a standard new Keynesian DSGE model and modify it to reconcile it with reality.
Blanchard said
Suppose you are writing two textbooks, one undergrad, one grad. In the undergraduate textbook, it seems to me that when teaching the IS-LM, [skip]
At the graduate level, we now have this explosion of DSGE models which put one friction and another into the model. Again, targeting pedagogy, it seems to me that there are two mechanisms which are central. The first is leverage, which starting with Ben [Bernanke's] work and earlier work we have, I think we know how to deal with it. The second is liquidity. And I think there we are much less far along the way. Again, I am hoping that someday we will put it together and have a simple way of thinking about leverage and a simple way of thinking about liquidity. These two things will come into our New Keynesian model, and we will be able to tell a simple story. We are at the stage at which the DSGE models have much too much in them to be fully understood.
