Journal Article

Modelling a complex world: improving macro-models

Warwick J McKibbin and Andrew Stoeckel

in Oxford Review of Economic Policy

Volume 34, issue 1-2, pages 329-347
Published in print January 2018 | ISSN: 0266-903X
Published online January 2018 | e-ISSN: 1460-2121 | DOI: https://dx.doi.org/10.1093/oxrep/grx056
Modelling a complex world: improving macro-models

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  • Econometrics and Mathematical Economics
  • Econometric Modelling
  • Mathematical Methods; Programming Methods; Mathematical and Simulation Modelling
  • General Equilibrium and Disequilibrium
  • Intertemporal Choice and Growth
  • General Aggregative Models
  • Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
  • Macroeconomic Aspects of International Trade and Finance

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Abstract

Macro models have come under criticism for their ability to understand or predict major economic events such as the global financial crisis and its aftermath. Some of that criticism is warranted; but, in our view, much is not. This paper contributes to the debate over the adequacy of benchmark DSGE models by showing how three extensions, which are features that have characterized the global economy since the early 2000s, are necessary to improve our understanding of global shocks and policy insights. The three extensions are to acknowledge and model the entire global economy and the linkage through trade and capital flows; to allow for a wider range of relative price variability by moving to multiple-sector models rather than a single good model; and to allow for changes in risk perceptions which propagate through financial markets and adjustments in the real economy. These extensions add some complexity to large-scale macro-models, but without them policy models can oversimplify things, allowing misinterpretations of shocks and therefore costly policy mistakes to occur. Using over-simplified models to explain a complex world makes it more likely there will be ‘puzzles’. The usefulness of these extensions is demonstrated in two ways: first, by briefly revisiting some historical shocks to show how outcomes can be interpreted that make sense within a more complex DSGE framework; then, by making a contemporary assessment of the implications from the proposed large fiscal stimulus and the bans on immigration by the Trump administration which have both sectoral and macroeconomic implications that interact.

Keywords: macroeconomics; models; risk; relative prices; DSGE

Journal Article.  7587 words.  Illustrated.

Subjects: Econometrics and Mathematical Economics ; Econometric Modelling ; Mathematical Methods; Programming Methods; Mathematical and Simulation Modelling ; General Equilibrium and Disequilibrium ; Intertemporal Choice and Growth ; General Aggregative Models ; Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook ; Macroeconomic Aspects of International Trade and Finance

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