After a round of hot debate on the problem of DSGE model and the trouble of macroeconomics initiated by Paul Romer, heavyweight macroeconomist Olivier Blanchard comment on the usefulness of DSGE model, again.

But before he discussed the future of macroeconomics, he comes up with a list of things that macroeconomists normally agreed on, and need no further discussions.

1. Macroeconomics is about general equilibrium.

2. Different types of general equilibrium models are needed for different purposes. For exploration and pedagogy, the criterion should be transparency and simplicity, and for that, toy models are the right vehicles. For forecasting, the criterion should be forecasting accuracy, and purely statistical models may, for the time being, be best. For conditional forecasting, i.e. to look for example at the effects of changes in policy, more structural models are needed, but they must fit the data closely and do not need to be religious about micro foundations.

3. Partial equilibrium modelling and estimation are essential to understanding the particular mechanisms of relevance to macroeconomics. Only when they are well understood does it become essential to understand their general equilibrium effects. Not every macroeconomist should be working on general equilibrium models (there is such a thing as division of labor).

And on the future of macroeconomics, Blanchard thinks that the priority should be on making New Keynesian model comprehensible as ISLM:

So, to me, the research priorities are clear:
First, can we write down a basic model most of us would be willing to take as a starting point, the way the IS-LM model was a widely accepted starting point earlier in time? Given technological progress and the easy use of simulation programs, such a model can and probably must be substantially larger than the IS-LM but still remain transparent. To me, this means starting from the New-Keynesian model, but with more realistic consumption- and price-setting equations, and adding capital and thus investment decisions.

Macroeconomists should also put the efforts on thinking about how best to incorporate factors like consumer behavior, financial intermediation etc into the DSGE models.

These are the discussions that must take place, not grand pronouncements on whether we should have DSGEs or not, or on the usefulness of macroeconomics in general.

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Further Thoughts on DSGE Models


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