I do not think that the currently popular DSGE models pass the smell test. ... The advocates no doubt believe what they say, but they seem to have stopped sniffing or to have lost their sense of smell altogether.
-- Robert Solow/2010
So, it all started with a question: is there a specific version of econometrics tailored to macro? When I was in school loe those many decades ago, there was just econometrics, exemplified by Theil's Godzilla book (you know, in the sense that it conquered all). I used Kmenta. Macro folks drifted to time series analysis, again with a seminal text, this time, by Box and Jenkins.
So, I let my fingers do the walking through the Yellow Googles. Turns out there is at least one text, "Structural Macroeconometrics". I got a copy and have been browsing. I hesitated in ordering, since the ToC had that hated word, Bayesian, sprinkled throughout. But, girding my loins as Taras Bulba commanded Andrei to learn the ways of the Poles, I went ahead with it. The hubris of the text is astonishing! Now, the copyright date is 2011, more than enough time for these authors to know that The Great Recession had occurred. And to know that the method they propound, DSGE (dynamic stochastic general equilibrium), was just as much a bust in predicting as all the other quant models.
The simple fact is The Great Recession was driven by The Rich seeking low-risk, high-return instruments rather than physical investment. They, lemmings all, settled on residential (and, to a lesser degree, commercial) mortgages. That's the matter. The anti-matter was the CDS, invented at a specific time and place by one person. A woman, of course. Pandora for our times. The CDS turned the metaphorical Wall Street Casino into a real one: anyone could bet on anyone else's assets. More bets than holdings. Oops.
Here's one view of DSGE and The Great Recession.
The failure of economists to predict the Great Recession of 2008 - 09 has rightly come under attack. The areas receiving most criticism have been economic forecasting and macroeconomic modelling. Distinguished economists - among them Nobel Prize winner Paul Krugman - have blamed developments in macroeconomic modelling over the last 30 years and particularly the use of dynamic stochastic general equilibrium (DSGE) models for this failure.
Which is not to say that merely reading the New York Times and Wall Street Journal, looking for, to use econ jargon, 'technology shocks' in the form of dangerous changes to the rules of engagement is sufficient. But the quant approach of predicting the future based on the past, even a recent one, won't spot such problems. A good job for a grad student RA.
So, we get this reporting. The like me quote:
The problem the major economies in Japan, Europe, and the United States have today, [Richard C. Koo, chief economist at Nomura Securities] said, is that despite low interest rates, investment opportunities in domestic markets don't offer sufficient returns to lure borrowers to go into debt, using the vast pools of available savings.
IOW, nothing has changed since the lemmings' surge into residential mortgages. The CxO class is still too stupid at finding physical investment. You like me. You really like me.
Another, truly rare, observation:
[federal budget deficits aren't] necessarily a forerunner of inflation. ... [other causes are] a shortage of labor, raw materials, and factories.
IOW, cost push. Greedy union workers aren't the only cause of inflation. Again, you like me. You really like me.
Most of the front page of the Business page is taken up with Neil Irwin's reporting on Australia's 'miracle'. You should read it.
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