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Modelling a complex world: improving macro-models

Author

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  • Warwick J McKibbin
  • Andrew Stoeckel

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.

Suggested Citation

  • Warwick J McKibbin & Andrew Stoeckel, 2018. "Modelling a complex world: improving macro-models," Oxford Review of Economic Policy, Oxford University Press, vol. 34(1-2), pages 329-347.
  • Handle: RePEc:oup:oxford:v:34:y:2018:i:1-2:p:329-347.
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    File URL: http://hdl.handle.net/10.1093/oxrep/grx056
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    References listed on IDEAS

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    1. McKibbin, Warwick J & Vines, David, 2000. "Modelling Reality: The Need for Both Inter-temporal Optimization and Stickiness in Models for Policy-Making," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 106-137, Winter.
    2. Tony Hall & Jan Jacobs & Adrian Pagan, "undated". "Macro-Econometric System Modelling @75," NCER Working Paper Series 95, National Centre for Econometric Research.
    3. Menahem E. Yaari, 1965. "Uncertain Lifetime, Life Insurance, and the Theory of the Consumer," Review of Economic Studies, Oxford University Press, vol. 32(2), pages 137-150.
    4. Adam Cagliarini & Warwick McKibbin, 2010. "Global Relative Price Shocks: The Role of Macroeconomic Policies," RBA Annual Conference Volume,in: Renée Fry & Callum Jones & Christopher Kent (ed.), Inflation in an Era of Relative Price Shocks Reserve Bank of Australia.
    5. Warwick J. McKibbin & Andrew Stoeckel, 2009. "Modelling the global financial crisis," Oxford Review of Economic Policy, Oxford University Press, vol. 25(4), pages 581-607, Winter.
    6. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
    7. repec:oup:oxford:v:34:y:2018:i:1-2:p:43-54. is not listed on IDEAS
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    10. Jenny Corbett & David Vines, 1999. "Asian Currency and Financial Crises: Lessons from Vulnerability, Crisis and Collapse," The World Economy, Wiley Blackwell, vol. 22(2), pages 155-177, March.
    11. Weil, Philippe, 1989. "Overlapping families of infinitely-lived agents," Journal of Public Economics, Elsevier, vol. 38(2), pages 183-198, March.
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    1. repec:eee:ecmode:v:72:y:2018:i:c:p:78-98 is not listed on IDEAS

    More about this item

    Keywords

    macroeconomics; models; risk; relative prices; DSGE;

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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