Applicability and Accomplishments of DSGE Modeling: A Critical Review

In the 1990s, the competition between Keynesian and Classical ideas on macroeconomics ended with the ‘the new neoclassical synthesis’. The synthesis led to the Dynamic Stochastic General Equilibrium (DSGE) models, which is regarded as a powerful instrument for analyzing policy, forecasting and governing Central Banks (CB). Discussion has been made on the evolution, value additions, advantages and downsides of macroeconometric–general equilibrium models and estimation methods. The purpose is to make a critical assessment of applicability and developments in DSGE modeling. A sample of 168 studies was considered for the analysis. More than 90% of the DSGE studies were conducted after the great recession of 2008/09. In developing countries, DSGE research is inadequate, for which a shortage of skills, awareness and the debates of its applicability in developing countries may be responsible factors. Its computational power and adaptability to a multitude of problems inspired 60% of studies to apply Bayesian techniques of estimation. Although DSGE has limitations, it continues to evolve its methodology and to be used by CBs. Based on its current state of development, the coexistence of DSGE with other policy analysis and forecasting models is recommended for improved policy decision making.