Development of the fundamentals of DSGE-modeling

Abstract

This article attempts to analyze the evolution of approaches that constitute grounds for macro modeling. The counteraction to destructive consequences of crises assumes practical use of model apparatus as a necessary tool for preventing destabilization. The article aims to study the progressive stages and identify unsettled issues and promising ways to assist macro models' evolution. The fundamental Marshall's and Walras's platforms supported progressive changes following the destructive Great Depression and Great Inflation in the USA in 1920-1970 and marked a new trend in macro modeling called dynamic stochastic general equilibrium (DSGE) models. The new instrument is remarkable for a radical change in macro modeling approaches, where microeconomics comes to the fore. DSGE models debuted by invoking four essential ingredients: the Phillips curve, adaptive inflation expectations, anchoring nominal prices, and an endogenous production function. The progression stages of theoretical approaches to macro modeling incorporate the classical and Keynesian schools' advanced innovations. The evolution of macro modeling has five generations of models: Keynesian, classical, RBS, new Keynesian, and new Keynesian DSGE models. Among advantages of DSGE models are "political neutrality," distinguishing the shocks into economic and political ones, and establishing the upshots of significant structural changes in the economy. The next generation of macro models is called to solve four pressing issues: establishing financial frictions, relaxing rational expectations, introducing heterogeneous agents, and underpinning the framework with more appropriate microfoundations.