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The Scientific Foundation of Dynamic Stochastic General Equilibrium (DSGE) Models

In: Exchange Rates and Global Financial Policies

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  • Paul De Grauwe

Abstract

DSGE-models provide a coherent framework of analysis. This coherence is brought about by restricting acceptable behavior of agents to dynamic utility maximization and rational expectations. The problem of the DSGE-models (and more generally of macroeconomic models based on rational expectations) is that they assume extraordinary cognitive capabilities of individual agents. In addition, these models need a lot of ad-hoc assumptions to make them fit the data. I argue that we need models that take into account the limited cognitive abilities of agents. One can introduce rationality in such models by assuming “trial and error” learning. I propose such a model and I analyze its implications.

Suggested Citation

  • Paul De Grauwe, 2014. "The Scientific Foundation of Dynamic Stochastic General Equilibrium (DSGE) Models," World Scientific Book Chapters, in: Exchange Rates and Global Financial Policies, chapter 17, pages 427-472, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814513197_0017
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