Dynamic Stochastic General Equilibrium, or DSGE model has been the most dominant recent macroeconomic model in the recent economic history. The name Dynamic Stochastic General Equilibrium does tell some interesting characteristic that the model possesses. “Dynamic” being the simplest part of the model just suggests that the model over goes a progress of constant change. The term “Stochastic” is defined as a correspondence to a particular type of manageable unpredictability built into the model that demonstrates events like oil shocks and/or technological changes. The model attempts to assume it can predict these shock mathematically and the events that the model cannot predict are simply uninsured and ruled out of the results. “General” means that the model incorporates almost all of the markets of our macroeconomic economy. The “Equilibrium” part of the model’s name shows that the model accepts that demand and supply balance out quickly and accurately, as well as these markets are assumed to have competition that is untouched by surpluses, shortages as well as involuntary unemployment.
The model that we talk about per say are not broken or failing but the main issue is that, the model is not dynamic enough for such large macroeconomy that we have today. The economy is always changing and there will be shocks that models will not be able to highlight or incorporate. As dynamic the economy is, to make an accurate model the model needs to be dynamic as well. The models that have been famous and are currently in place might work for a period of time but will always fail in the end due to their unchanging nature.
Neo-Classical Economics is a form macroeconomic thought that was based on incorporation of rational expectation theory in the through 60s and 70s. This means that the macro economy is made of many individuals who make the best decisions that they possibly can and will drive the economy. This economic model is highlighted by a type of monetarism that considers the demand management system by any type of government is absolutely ineffective even in the short run, and this makes people and support tax cuts. The theory suggests that participants in this economic model will try their best to reach highest utility possible while firms produce and maximize their profits. Firms will produce until marginal revenue will be equal to marginal cost. Neo-Classical economic theory will view all markets perfectly competitive.
New Keynesian Economics
New Keynesian Economics is an economic theory that takes in consideration the Micro foundations that Lucas found to be so important when trying to illustrate the Macro economy. This included the acceptance of rational expectations assumptions, which means that people will act only in the most beneficial way that makes since to them while knowing most of the information that is attainable to them. The theory also accepts that firms will not participate in perfect competition but will participate in monopolistic competition. In markets, New Keynesians believe that wages and prices will be “sticky”: market failures and involuntary unemployment is potentially possible while the government intervention attempts to keep the economy in equilibrium.
Unfortunately my descriptions of different economic thoughts that we have discussed this semester won’t make the final paper, but here they are for your viewing pleaser!
The first class of economics which had kicked off the main study of economics was the classical view of the economy. There was no differentiation between Macroeconomic or Microeconomic theory, but they did use evidence of microeconomic theory that we know of today and had applied it to macro economy to predict it. One of the most important conditions of the Classical Economic theory is that there is always perfect information in the market. There are zero transaction costs, all transactions are voluntary ,and there is an infinite number of buyers and sellers. These factors made the classical focus more on the supply side of the equilibrium. This was due to the classical economic thought that was developed by Jean Baptiste Say which had assumed: supply creates its own demand which had made an assumption that there will be no hoarding in the economy due to all income is either spent or saved (that it is invested). Another thing to add is that if there is excess supply then there will be excess demand, everything is evened out and there will never be excess supply in the economy. This assumption; Walras’ Law, if one good is more desirable it will rise in price, while less desirable goods will fall in price and aggregate supply side will never change.
The basic idea behind the Keynesian economic model is economic theory of total spending in the economy and its effects on output and inflation. This theory and idea was brought up by John Keynes who was a British economist. He stumbled upon his believes by attempting to identify the factors behind the Great Depression. He had concluded that increased government expenditures as well as lower taxes will stimulate demand and influence the economy out of the Depression. This had led to a belief that optimal economic performance may one day be accomplished. This demand side theory of “Keynesian economics” suggest that ideal and efficient performance by the economy may be achieved and economic decline and detraction may be prevented by economic intervention by the government which would create policies to influence the aggregate demand.
I was browsing the interweb this week and had stumbled upon this very interesting tweet from a multi-billionaire Mark Cuban:
This had really made me think about what will happen in the future (when robots are mostly in charge of production of goods and not humans.) What will happen to unemployment? Will people just reclass to different jobs or will they be completely unemployable and not beneficial to the society that we are living in. Mr. Cuban had also brought up a very interesting point, that the robots that are producing should be taxed on how much they are making. That is saying that we should be taxing the capital that is producing for us. What do you think about the statement that he had made, and how will this affect our future economy?
My definition of rational expectation theory is people absolute best guess at what will happen in the future while using the things that have happened in the past, that they have learned over a period of time. This means that people do not make errors while predicting the future and they use ALL of the information that they have observed and learned to make a most intelligent decision possible.
Do people have rational exceptions? – What have people not learned from their mistakes.
I believe that as a whole, rational expectation does not exist. People are very irrational at times and don’t learn from the past most of the time due to things “feeling good”. We as irrational beings mostly rely on feelings for most of our decisions. If humans were a robots and actually had learned from the past to make a future decisions (and not did what felt good,) then we would be able to accurately make rational expectations.
While reading the book, Prosperity for All, by Roger E.A. Farmer, my favorite chapter so far was, chapter 2, Keynes Betrayed. In the section “Classicals, Keynesians, and Bastard Keynesians,” the author had made a comparison,
“The economy is like a boat on the ocean with a broken rudder. As the club hits the rocking horse, so the wind blows the boat. In the windy boat metaphor, there is no self-correcting market mechanism to return the boat to a safe harbor. We must rely, instead, on political interventions to maintain full employment.”
It’s a very interesting view and made me think about how interpret the economy. I do agree with the statement that the author has made but I also have a few issues with it. I believe there is no such thing as full employment. It’s a hypothetical condition that will only happens in a perfect world, in our world and the free market economy we have it will never be achieved. This due to people that are willing and able to work are will always look for jobs. This is like saying that McDonald’s, that had 1.9 million employees in 2015, will not have a single job opening at any point in time, simply will never happen. Comparing this to a large economy that we have today is simple, people will always look for jobs and be unemployed for a certain period. I do agree though that we need to rely on political interventions, by raising and decreasing interest rates (Inflation Targeting), is one of the ways that political intervention may change the unemployment level. With higher rates the number of people that are looking for work will hypothetically increase. To summarize my thoughts, I believe that even if the economy is working the best it can and the interest rate is at 0% there still will be some sort of levels of unemployment. EX. Japan having a -.18% interest rate but still has a 3% unemployment rate, can anyone explain this?