SFC vs. DSGE (Again)

There was a recent set of articles discussing Stock-Flow Consistent (SFC) and Dynamic Stochastic General Equilibrium (DSGE) models; an initial article by Simon Wren-Lewis (link), which led to responses by others; I would recommend these two articles (link and link) by Ramanan.


The discussion was civil, which is partially the result that Simon Wren-Lewis agrees that the fixation on "microfoundations" makes very little sense. However, since it is still insisted upon by mainstream academics as being necessary to get published in mainstream journals, his flexibility is not particularly representative.

The following argument by Wren-Lewis is interesting.

Mainstream macroeconomics addiction to microfoundations methodology has given heterodox economists an opportunity. If mainstream macro continues to shun what it calls policy models (models that use aggregate relationships justified by an eclectic mix of theory and data), then this space can be occupied by others. But to do that heterodox economists have to stop being heterodox, by which I mean defining themselves by being against almost all mainstream theory. As Jo Michell writes “The problem with heterdox economics is that it is self-definition in terms of the other”. As the scope and diversity of mainstream theory gets larger and wider, the space that can be occupied by those who reject the mainstream shrinks.

I would like to agree with this sentiment, but I differ on the value of mainstream economics.

The mainstream methodology within macroeconomics largely consists of writing down an overly complex model, wave hands about trying to solve the model (linearisation, etc.), and then draw conclusions from the model results (which are often asserted, as there is little indication of solving the mathematics properly). The verbal description of the model results are then presented as being policy relevant.

However, the initial model used is wildly unrealistic, and so critics could obviously point out that the conclusions are wrong. (For example, no financial sector.) The response is to create a completely different unrealistic model in another paper which handles that particular objection, and then draw new policy conclusions -- verbally.

This sequence of verbal observations is what is providing the apparent diversity of mainstream macro. The mathematical models themselves are a sequence of unrealistic messes that are not coherent with each other.

Constructive Advance

Once I finish up the remaining sections of my latest book (on money), I expect that I will be writing a more technical work about some  post-Keynesian approaches to the business cycle. (I cannot hope to cover all of them.)

My objective is not to advance post-Keynesian theory, rather give my spin as an outsider on the theory. The idea is that it will be an (advanced) primer on post-Keynesian economics, shorter (and cheaper!) than the various textbooks that are available.

 As I have previously discussed, I am skeptical about the ability of any model to forecast the economy in a reliable fashion. (During an expansion, growth follows a steady trend, so any methodology that extrapolates past behaviour is going to look good -- until the recession hits.) However, mathematical models still provide some useful input to our thought processes. I hope to be able to demonstrate the usefulness of methods (such as SFC models), even if we cannot hope to have a perfect crystal ball.

For the purposes of business cycle analysis, the various post-Keynesian approaches I will cover will be an improvement over DSGE macro. The "big insight" from DSGE macro is that recessions are caused by inexplicable collapses in productivity. That is setting the bar very low for competing approaches.

See also:

• My resource page for SFC models/Modern Monetary Theory.
• Jo Michell also has a good discussion, including how the name "stock-flow consistent" models was somewhat unfortunate. (UPDATE)

(c) Brian Romanchuk 2016