comment on Krugman

Most of what I type below is stuff I’ve typed at Angrybear many times. It’s here because I ran into the Krugman blog 1500 character limit over there.

I’m commenting on two bits

intertemporal equilibrium all the way, with consumers making lifetime consumption plans, prices set with the future rationally expected, and so on. That’s DSGE — and I think Glasner and I agree that this hasn’t worked out too well.

and

Glasner says that temporary equilibrium must involve disappointed expectations, and fails to take account of the dynamics that must result as expectations are revised. I guess I’d say two things. First, I’m not sure that this is always true. Hicks did indeed assume static expectations — the future will be like the present; but in Keynes’s vision of an economy stuck in sustained depression, such static expectations will be more or less right. It’s true that you need some wage stickiness to explain what you see (which is not the same thing as saying that sticky wages are the cause of unemployment), but that isn’t necessarily about false expectations.

my comment

I think it might be useful to stress the two very different relevant meanings of the word “equilibrium”. Sometimes it means Nash equilibrium. Sometimes it means Walrasian equilibrium. Sometimes it means stationary around a unique stable flexible price equilibrium.

I think this is relevant to the post at two points. One is “plans, prices set with the future rationally expected, and so on. That’s DSGE. ”
The other is “in Keynes’s vision of an economy stuck in sustained depression, such static expectations will be more or less right.”

I think it is possible to write down a model of an economy with a Nash equilibrium that is to be stuck in sustained depression. This can happen with intertemporal optimization all the way.

The DSGE models in the mainstream macro literature share strong assumptions other than intertemporal optimization. The modelling strategy includes the assumption that there is a unique flexible price equilibrium and that (correctly scaled) actual outcomes have a stationary distribution around it. The shared assumption isn’t just Nash equilibrium. So for example, with the same assumptions about tastes and technology and with monetary policy a Taylor rule, the equilibrium can be determinate or indeterminate depending on the parameters of the Taylor rule. So it is standard to assume parameters such that it is determinate. This is part of the approach called DSGE but it does not follow from D, S or GE. Here “equilibrium” has the third meaning which is not implied by Nash equilibrium.

I think part of the problem with macro theory is that the meaning of equilbrium is elastic so the meaning of “equilibrium models are useful” is slippery– the broad unfalsifiable meaning is used when it is to be tested and the narrow plainly false meaning is used when it is to be applied.

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