Roberta Cardani, Olga Croitorov, Fabio Di Dio, Lorenzo Frattarolo, Massimo Giovannini, Stefan Hohberger, Philipp Pfeiffer, Marco Ratto, Lukas Vogel, 08 September 2021

The COVID-19 recession differs strongly from past crises in recent history. This column summarises the integration of key economic features of the pandemic into the European Commission’s estimated DSGE model. Shock decompositions highlight the dominant role of ‘lockdown shocks’ (‘forced savings’, labour hoarding) for explaining the quarterly pattern of real GDP growth in 2020, complemented by negative contributions from foreign and investment demand notably in 2020q2 and a negative impact of persistently higher (precautionary) savings. The inflation response has been modest given the severity of the recession.

Manuel A. Muñoz, 14 November 2020

Institutional real estate investment has more than quadrupled in the euro area since 2013, financed largely through non-bank lending, which is not subject to regulatory loan-to-value limits. This column uses a two-sector model of institutional real estate investors calibrated to quarterly data from the euro area economy to show that optimised (countercyclical) loan-to-value rules limiting the borrowing capacity of such investors are more effective in smoothing property price, credit, and business cycles than the well investigated dynamic loan-to-value rules that affect (indebted) households’ borrowing limit. The findings call for a strengthening of the macroprudential regulatory framework for non-banks.

Francesco Furlanetto, Ørjan Robstad, Pål Ulvedal, Antoine Lepetit, 09 November 2020

Modern macroeconomic models imply that demand factors have only a small transitory effect, if any, on the productive capacity of the economy. By extending the econometric framework proposed by Blanchard and Quah, this column enables fluctuations in aggregate demand to have a long-run impact on the productive capacity through hysteresis effects. It finds that these demand shocks are quantitatively important in the US, in particular if the Great Recession is included in the sample. More specifically, demand-driven recessions lead to a persistent decline in employment and investment but leave labour productivity largely unaffected.

Patrick Minford, 04 January 2015

Out-of-sample forecasting tests are increasingly used to establish the quality of macroeconomic models. This column discusses recent research that assesses what these tests can establish with confidence about macroeconomic models’ specification and forecasting ability. Using a Monte Carlo experiment on a widely used macroeconomic model, the authors find that out-of-sample forecasting tests have weak power against misspecification and forecasting performance. However, an in-sample indirect inference test can be used to establish reliably both the model’s specification quality and its forecasting capacity.

David Hendry, Grayham Mizon, 18 June 2014

Many central banks rely on dynamic stochastic general equilibrium models – known as DSGEs to cognoscenti. This column – which is more technical than most Vox columns – argues that the models’ mathematical basis fails when crises shift the underlying distributions of shocks. Specifically, the linchpin ‘law of iterated expectations’ fails, so economic analyses involving conditional expectations and inter-temporal derivations also fail. Like a fire station that automatically burns down whenever a big fire starts, DSGEs become unreliable when they are most needed.

Charles Goodhart, Dimitri Tsomocos, 26 November 2009

Standard DSGE models do not include the possibility of default. This column says that makes them useless for analysing financial crises. It proposes explicitly incorporating default and money into the microfoundations of DSGE models so as to offer a new framework for monetary and regulatory policy analysis.

Paul De Grauwe, 19 November 2009

The extraordinary assumptions of macroeconomic models have left the outside world perplexed about what economists have been doing during the last few decades. This column contrasts the incongruous rational expectations top-down model with a bottom-up model where no individual is capable of understanding the full complexity of a market system. The bottom-up model creates correlations in beliefs that generate waves of optimism and pessimism. The latter produce endogenous business cycles akin to the Keynesian “animal spirits”.

Alan KIrman, 14 November 2009

How will economic theory emerge from the global crisis? This column says that representative agent models and the efficient markets hypothesis are assumptions that have persisted too long in the face of empirical evidence. It argues that economic theory is due for an overhaul but fears that economists will resist such change.


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