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The document discusses dynamic stochastic general equilibrium (DSGE) models, including how they incorporate microfoundations, dynamics, general equilibrium, and various shocks to make quantitative predictions about how economies respond over time. It covers the history and evolution of DSGE models from real business cycle models to modern models that include more features and shocks.

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Patrik Frei
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Download as PDF, TXT or read online on Scribd
24 views

VL

The document discusses dynamic stochastic general equilibrium (DSGE) models, including how they incorporate microfoundations, dynamics, general equilibrium, and various shocks to make quantitative predictions about how economies respond over time. It covers the history and evolution of DSGE models from real business cycle models to modern models that include more features and shocks.

Uploaded by

Patrik Frei
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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15.

1 Introduction
In this chapter, we learn
how business cycle models and growth
models are connected at the frontier of
macroeconomics.
that DSGE models incorporate
microfoundations, dynamics, general
equilibrium, and a panoply of shocks.
that DSGE models make quantitative
predictions about how the economy
evolves over time in response to shocks.

15.2 A Brief History of DSGE Models


Real business cycle models
Very first DSGE models
Used Solow model of growth to study
macroeconomic fluctuations
Introduced total factor productivity
(TFP) shocks
Positive shock: new technology,
institutions
Negative shock: institutions, taxes

Economy starts in equilibrium

Real shock: Productivity increases


Working more pays off
Firms hire workers, unemployment goes down
Workers earn more, consume more, save more
Investment increases, capital increases, MPK
decreases, etc. etc.
Eventually the effects of every single shock peter out,
but shocks of different sign and size occur again and
again in an unpredictable way
Economic variables fluctuate, business cycles arise

Modern DSGE models include more shocks


(real and nominal, international, financial)
Are built using these types of components:
endogenous variables
shocks
and features of the economy that affect the
way shocks impact endogenous variables
over time (incorporated in equations).

Features and Mathematics


Different DSGE models often involve
different features of the economy.
Nominal rigidities
Adjustment costs
Heterogeneity
Incomplete markets

DSGE models are complex to solve


mathematically because they involve
many individual decisions.

Dynamic stochastic General


Equilibrium
Economy consists of
Households
Firms
Government
Central bank
Their (forwardlooking, optimizing)
behavior is described
with equations

optimizing
behavior
results in

Dynamic
evolution of:

Question: How does a stochastic shock feed through


the economy? How do the variables react?

15.5 Quantitative DSGE Models


Full DSGE models incorporate the
complete dynamic response of all
economic variables to all shocks.
The Smets-Wouters model
incorporates all the shocks weve
discussed earlier and includes both
sticky prices and sticky wages.

Impulse Response Functions


An impulse response function shows how
one macroeconomic variable of interest
responds over time to an economic shock.
The next slide shows the impulse response
function for GDP in the estimated SmetsWouters model:
By what percent does GDP change after a
temporary 1 percentage point increase in the
fed funds rate?

Models within the DSGE framework make


precise quantitative predictions about the
complete dynamics of a host of endogenous
variables.
It is the most complete framework economists
have to study and understand macroeconomic
fluctuations
The models weve seen so far are a just first
step

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