DSGE is – to many economists – the standard model and method of macroeconomic analysis. See our treatment of the textbooks’ IS-LM, AD-AS and Phillips Curve Models.
The acronym stands for Dynamic (an external force causes a change to constant velocity, i.e. an acceleration, which may be negative or positive), Stochastic (random, not according to system, probabilistic, unexplained) General (pertaining to the entire economic process), Equilibrium (essentially Walrasian static equilibrium).
Leon Walras developed the conception of the markets as exchange equilibria. Concentrate all markets into a single hall. Place entrepreneurs behind a central counter. Let all agents of supply offer their services, and the same individuals, as purchasers, state their demands. Then the function of the entrepreneur is to find the equilibrium between these demands and potential supply. … The conception is exact, but it is not complete. It follows from the idea of exchange, but it does not take into account the phases of the productive rhythms. … [CWL 21, 51-52]
The textbook models employ comparative statics: Certain quantities are accepted as initially given; their determination is exogenous; then they themselves are changed by some external shock and considered to be parameters over which the endogenous firms and households have no initial control. Other quantities are considered to be endogenous variables determined by adjustments within the comparative-statics framework. However, in truth even the adjustments by participants are treated as though the participants are, as it were, outside the system. For example: in an initial configuration, prices may be exogenously given and determinate of a certain endogenous intersection-equilibrium of quantities along the supply and demand curves. Then, an exogenous, unexplained shift in prices is assumed, to which the internal human agents of supply and demand respond to effect a different intersection of the quantities of supply and demand. Comparative statics is, thus, characterized by exogenous givens, unexplained shifts in the exogenous givens, and consequent efficient-cause adjustments by supposedly-endogenous households and firms to the framework’s variables of price and quantity; all such that the adjustments by humans are the last efficient cause of a new intersection of the endogenous variables. Thus, the process is a matter of serial efficient causes; there is no concept of primary relativities, immanent intelligibility, formal cause, or set of coherent explanatory relations, prior to and more fundamental than DSGE’s efficient cause.
While comparative statics demonstrates the general principles of supply equaling demand and of quantities having prices, it does not explain the dynamic economic process by the terms and relations of interdependent functionings. In comparative statics there is a whole lot of assuming and guessing going on with respect to the shape of curves and the nature, direction, and extent of different possible reactions. CS is a huge tangle of psychopolitical guesses regarding profit-seeking firms contending with utility-seeking households, reactions to change and to the expectations of change, and the speed of the reactions. And it stakes what it thinks are explanations in the psychological and political winds of the imagination. In such an imaginary tangle, so-called pundits can cherry-pick elements in order to extrapolate as they feel, and make predictions as they will, when in the general case predictions of the longer term are impossible. So, we have financial talk shows and political debates.
In contrast, Functional Macroeconomic Dynamics is a theory of the formal cause, or immanent intelligibility, or primary relativities, of a current, continuous or semicontinuous, purely dynamic process of interdependent, functional flows. Its basic terms are few implicitly-defined, and determinate; these terms are precisely defined by the functional relationsin which they stand with one another; thus, they are of scientific and explanatory significance; and their magnitudes are determinate. FMD is purely relational. Its terms are not known in and of themselves but rather are defined by their relations to one another. It is a dynamical analysis of a dynamic process. It is conceptually prior to, more fundamental than, and independent of human psychology. It is also a normative theory which provides the norms and precepts to which human psychology must adapt.
Functional Macroeconomic Dynamics constitutes a new and better standard model. FMD has, so far, been looked at by only a few professional economists; and it fights resistence by those who have a reputational and pocketbook stake in DSGE.
I have been told by members of economics departments in first, second, and third world nations that the distinction is familiar, or interesting, or whatever, but not worth pushing. My colleagues in mathematical physics exhibit quite a different tone and tension of interest and openness. What a prioriarrogance can make a science that is in a mess pass judgment on the worth of an obviousdistinction: all the more obvious, as we shall see, when we turn our attention to innovation and development? [McShane 2002-2, 22-23]
I am inclined to think that the main difficulty is the subtle absence of the scientific spirit in contemporary economics. … There is nothing wrong with mathematical rigor: the rigor mortis belongs to the absence of significant variables coupled regularly with the absence of empirical and pragmatic perspective; a case in point is the sophistication of rational expectation theory. …; The real difficulty … is in the scientific perspective that can come to grips with precise functional distinctions. … What a priori arrogance can make a science that is in a mess pass judgment on the worth of an obvious distinction … ?[McShane 2002-2, 22]
Though it may take more time than it should, FMD will ineluctably come to the fore.
… if they denounce you as a fool in your life-time, their sons will mistake you for a genius when you are dead. For they are indifferent to truth and falsity; they are concerned only with the familiar, which they strive to maintain, and with the unfamiliar, which they strive to oppose … people that cannot be persuaded by the suddenness of intelligence and reason, are easily convinced by the slow but inevitable gradualness of time. So it is in the sciences. For scientific method does not succeed in teaching old dogs new tricks. As Max Planck testified, a new scientific position gains general acceptance, not by making opponents change their minds, but by holding its own until old age has retired them from their professorial chairs. [CWL 3, 526/549]; and M. Planck, Scientific Autobiography and Other Papers; E.T. by F. Gaynor; New York 1949, p. 33 f
Every independent variation – considered by DSGE as exogenous and called a “shock” – in the monetary flows constituted by prices of quantities constituting flows involves two groups of participants, and the flow is pretio-quantital, i.e. it is composed of both prices and quantities and the same flows can be differently composed. For example, outlays which become incomes involve both enterepreneurs and workers, and are composed of pretio-quantital flows. In special relativity, space-time, or spatio-temporality, has four dimensions intertwined with one another in variable ways. And in a closed economy, by dint of a) implicit definition and mutual conditioning among functionings, b) crossover relations between distinct functional circuits, and c) cycles composed of phases, a variation in one conditioning and conditioned flow may involve a pretio-quantital compensating change in three other flows within the field-theoretic complex of Gross Domestic Functional Flows.
Prescinding from a) dealings with the Redistributive Function and b) foreign trade, consider
GDFF = P’Q’ + Π”Κ”= p’a’Q’basic to self+ p”a”Q”Basic R&M + π”α”Κ”Pure expansionary surplus+ π”α”Κ”Surplus R&M to self [CWL 15, 156-62]
Pretio-quantital flows of supplying and selling in distinct functional circuits are implicitly defined by the functional relations in which they stand with one another. The changes associated with every shock can be multiple; outlays which become incomes have two groups of participants; expenditures which become receipts have two groups of participants; crossover flows bridge two circuits. What is outflow to firm is inflow to worker; what is outflow to buyer is inflow to seller; what is outflow to Smith is inflow to Jones.
In the GDFF formula above, there are four “costs” flows symbolized on the right side of the equation constituting the total “revenues” flow symbolized on the left. In this implicit equation, the equals sign indicates an identity. The identity constitutes a situation of No Entry From Outside and No Escape From Co-Operatives Within.
There is a sense in which one may speak of the fraction of basic outlay that moves to basic income as the “costs” of basic production. It is true that that sense is not at all an accountant’s sense of costs; … But however remote from the accountant’s meaning of the term “costs,” it remains that there is an aggregate and functional sense in which the fraction… is an index of costs. For the greater the fraction that basic income is of total income (or total outlay), the less the remainder which constitutes the aggregate possibility of profit. But what limits profit may be termed costs. Hence we propose ….to speak of (c’O’ = p’a’Q’) and (c”O” = p”a”Q”) as costs of production, having warned the reader that the costs in question are aggregate and functional costs…. [CWL 15, 156-57]
There is, first, a mutual conditioning between the prices and quantities of a given flow. And, second, there is a mutual conditioning between conceptually distinct, but interdependent, flows.
Mutual conditioning involves a peculiar impossibility relevant to analysis and understanding. Only by knowing all there is to know about conditioner A can one state all there is to be known about conditioned B. But only by knowing all there is to be known about B can one know all there is to be known about A. The proviso about A is the conclusion about B; and the proviso about B is the conclusion about A.
There results the peculiar type of impossibility that arises from mutual conditioning. Granted complete information on a totality of events, one could work out from knowledge of all laws the concrete pattern in which the laws related the events in the totality. Again, granted knowledge of the concrete pattern, one could use it as a guide to obtain information on a totality of relevant events. But the proviso of the first statement is the conclusion of the second; the proviso of the second statement is the conclusion of the first; and so both conclusions are merely theoretical possibilities. For the concrete patterns form a non-systematic aggregate, and so it is only by appealing to the totality of relevant events that one can select the concrete pattern; on the other hand, the relevant totality of events is scattered, and so they can be selected for observation and measurement only if the relevant pattern is known already [CWL 3, 650/672-73]
Thus, when one pretio-quantital flow in the complex economic process varies independently of the others, it is impossible to predict the pretio-quantital changes which will result among all flows. For while the relations among the fows are precisely distinguished and formulated, it is impossible to predict what will be the changes of pretio-quantital flows in the other flows for the simple reason that prices and quantities are secondary determinations in a non-systematic manifold.
The exchange-pricing solution will handle the complex of operative exchanges among individual persons or entities; however, accurate predictions of these changes and changes based upon these changes are impossible to make in the general case; for the primary relativities of functional flows to one another must be complemented by secondary determinations or prices and quantities from a non-systematic manifold.
… the exchange solution is a dynamic equilibrium resting on the equilibria of markets. … every product of the exchange economy must mate through exchange with some other product, and the ratio in which the two mate is the exchange value. The generality of this equilibrium makes it indifferent to endless complexity and endless change; for it stands on a level above all particular products and all particular modes of production. While these multiply and vary indefinitely, the general equilibrium of the exchange process continues to answer with precision the complex question, Who, among millions of persons, does what, among millions of tasks, in return for which, among millions of rewards? Nor is the dynamic solution unaccompanied by a continuous stimulus to better efforts and more delicate ingenuity. For the uniformity of prices means that the least efficient of those actually producing will at least subsist, while every step above the minimum efficiency yields a proportionately greater return. [CWL 21, 34-35]
The excellence of the exchange solution becomes even more evident when contrasted with the defects of a bureaucratic solution. The bureaucrat … (gives the people) what he thinks is good for them, and he gives it in the measure he finds possible or convenient; nor can he do otherwise, for the brains of a bureaucrat are not equal to the task of thinking of everything; only the brains of all men together can even approximate to that. … when a limited liability company has served its day, it goes to bankruptcy court; but when bureaucrats take over power, they intend to stay. … when the pressure of terrorism is needed to oil the wheels of enterprise, then the immediate effect is either an explosion or else servile degeneracy. [CWL 21, 34-35]
DSGE vs. FMD
Table of Differences and Implied Criticism
|Number of circuits||Single||Two or more|
|Premises||Production; microeconomic monetary self-interest||The macroeconomic structure and laws of production and monetary circulation prior to human psychology|
|Heuristic and method||Common sense corrections and remedies; explanation by efficient causality||Scientific, dynamic 2nd-order equations of continuity and equilibrium; complete explanation|
|Basic terms||Accountants’ prices and quantities||Scientists’ velocities and accelerations of implicitly-defining, mutually conditioning functionings|
|Primary intelligibility||Shocks from without and psyche-based, self-interested adjustments within||Invariant, endogenous, abstract primary relations among interdependent functions|
|Temporality||Report the accounting past and predict the serial future||Discover the immanent intelligibility to apply to the secondary determinations of the non-systematic manifold|
|Analytic distinctions||Shocks and adjustments||Point-to-point and point-to-line relations of factors; costs vs. pure investment income|
|Origin and employment of concepts||Picked up sporadically; attempt to relate non-scientifically and non-explanatorily||Insight generates mutually- and implicitly-defining concepts; concepts fix relations and relations fix concepts|
|Nature of shock or variation||Sudden, unexplained, unexpected, large; can be domestic or foreign||Of any magnitude; can be small and gradual as well as large and sudden; can emerge endogenously or from foreign trade|
|Emphasis in the meaning of “dynamic”||External force unexpectedly applied||First –order velocities and second-order accelerations of interdependent functionings|
|Causality; Newton vs. Legendre, d’Alembert, Lagrange, Hamilton, and Einstein||Efficient causality: in both external shocks and in internal adjustments by humans||Formal causality: immanent intelligibility, field theory of internal relations among n objects|
|Interest rate||An external given; manipulable for correction of distortions||An internal relation among explanatory conjugates of primary relativities|
|Pricing||External given||Understood in light of significant variables|
|Indexes (conjugates) of explanation||Accounting unities||Interdependent, mutually conditioning, explanatory functionings defined by their relations to one another|
|Prediction||Believed possible and expected to be realized||Known to be impossible in the general case|
Examples of DSG’s EXOGENOUS shocks
DSGE takes the position that, absent exogenous shocks, the economy would evolve along a perfectly predictable path, with neither booms nor recessions. (Sounds like Newton’s First Law of motion!) Note that some of DSGE’s so-called exogenous shocks are really endogenous, occurring routinely as constituents of the system.
- Changes in household’s psychology of willingness. … a demand shock which affects desired consumption and saving
- Exogenously caused inflation, e.g. OPEC’s change of price and supply of oil
- Changes in employment
- Increased or decreased production – a supply shock
- Changes in government’s supplying and demanding
Examples of FMD’s ENDOGENOUS developments in secondary determinations of the non-systematic manifold; (can be slow or fast, major or minor):
- Actual invention, production, and installation of physical capital (fishers’ nets, hunter’s spears, farmers’ ploughs, water wheel, steam engine, railroads, internal combustion engine, autos, applied science, computers, software, precision manufacturing)
- Actual improvement in skills, i.e. development of human capital
- Actual inflation due to scarcity of capacity or materials
- Manipulation of interest rates, i.e. price-fixing of the rental of money
- Usual minor changes in weather
- Natural disasters
An analytic framework is needed for the interpretation of changes in a field-theoretic economic process.
Lonergan agreed with Schumpeter on the importance of systematic or analytic framework in order to explain, rather than merely record or describe, the aggregate phenomena of macroeconomics; he agreed with Schumpeter that to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted. According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]
Functional Macroeconomic Dynamics views and understands DSGE’s shocks in the context of a dynamic field theory. For reference and for assistance in analyzing shocks, the reader is referred immediately below to Formulas, and Diagrams of Primary Relativities, expansionary Pure-Cycles, and superposed circuits of government and foreign trade imbalances.
The Topic entitled Edifice of Formulae is incorporated herein by reference.
The reader is encouraged to copy, print, trim, and tape, first, side by side, then, top to bottom including vertical lines identifying the different phases, the table and diagrams:
Primary relativities, universally relevant and applicable in any instance
- Table of possibilities; [CWL 15, 114]
- Figure 14-1, Diagram of Rates of Flow [CWL 15, 55]
- Formulae on CWL 15, pages 53-4
Pure Cycle Diagrams:
- Bar graph of income strata, and average propensities [See CWL 15, Cycle of Basic Income]
- Figure 24.4 [CWL 15, 122]
- Figure 24.6 [CWL 15, 124
- Figure 24-7, [CWL 15, 125]
- Figure 27.1 [CWL 15, 150]
- Figure 29.1 [CWL 15, 164]
Context for analysis and interpretation of changes or “shocks”
Top to Bottom delineating phases
To interpret and explain – rather than merely postulate – any change or “shock” in prices and quantities, one must identify
- The functional flow in which the change resides
- The flows of which the change is a constituent
- The other flows to which the change-flow functionally relates
- The possibility of substitutional affects in the market-pricing solutions
- The current phase of the economic process
- The change-in-basis of the economy per the lagged technical accelerator
kn[f’n(t-a)-Bn] = f”n-1(t) – An-1 (CWL 15, 37)
Is the change a change of price, quantity, money supply, technological basis, tax law? Is it a constituent of basic activities or surplus activities? How does it affect the current phase of expansion? Are its major effects practically-immediate point-to-point effects, or longer-term point-to-line effects?
The effect on the rates of production of consumer goods will depend on whether the capital goods are for mere replacement and maintenance, expansion of existing types of capital goods (widening), or production of newer or more efficient capital goods (deepening) to either replace existing types or add to the stock of capital goods. In the case of more efficient capital goods, the technical coefficients change and the production process is calculated on a new basis. The gas-powered tiller replacing the horse–drawn tiller puts production on a new basis. The advent of computers and software puts the national economy on a new basis.
And, in the interpretation of change, it is to be noted that long-term acceleration is a massive affair. (Cotton gin, looms, spinning machines) The complexity of an advanced economy is such that many units of enterprise combine to contribute over long periods of time to bring forth a final consumer good. Thus an expansion of the aggregate of consumer goods does not follow instantly upon the invention of a single capital product.
Lonergan goes dynamic in this way right from the beginning. He classifies all goods in terms of their dynamic production relations with one another, in a hierarchical system of difference differential equation accelerators corresponding to the various possible levels of capital deepening. In the interests of simplicity, however, he has just one aggregate consumption good, as is usual in macroeconomics. (Burley, 1992, 252)
Catalog of Criticisms of DSGE
We quote from Sbordone et al. and add cryptic comments.
Sbordone, Argia M., Andrea Tambalotti, Krishna Rao, Kieran Walsh, (2010) Policy Analysis Using DSGE Models: An Introduction, FRB Economic Policy Review, October, 2010 https://www.newyorkfed.org/research/epr/10v16n2/1010sbor.html [Sbordone, Tambalotti, Rao, Walsh, 2010]
The remainder of this section is still under construction.
 Also, it is possible for the economy to experience a deepening yet remain in a static phase if the productive rates of the liquidations equal the productive rates of the deepenings. See section on Additional or More Efficient Capital Equipment (p. 109 as of 7/14/12)