Another very clear and consise explanation, Lars…
Noah Smith has a nice piece up today on what he considers the most “damning critique of DSGE:”
If DSGE models work, why don’t people use them to get rich?
When I studied macroeconomics in grad school, I was told something along these lines:
“DSGE models are useful for policy advice because they (hopefully) pass the Lucas Critique. If all you want to do is forecast the economy, you don’t need to pass the Lucas Critique, so you don’t need a DSGE model.”
This is usually what I hear academic macroeconomists say when asked to explain the fact that essentially no one in the private sector uses DSGE models. Private-sector people can’t set economic policy, the argument goes, so they don’t need Lucas Critique-robust models.
The problem is, this argument is wrong. If you have a model that both A) satisfies the Lucas Critique and B) is a decent model…
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