Macroeconomic Policy in DSGE and Agent-Based Models Redux: New Developments and Challenges Ahead

Abstract

The Great Recession seems to be a natural experiment for economic analysis, in that it has shown the inadequacy of the predominant theoretical framework - the New Neoclassical Synthesis (NNS) - grounded on the DSGE model. In this paper, we present a critical discussion of the theoretical, empirical and political-economy pitfalls of the DSGE-based approach to policy analysis. We suggest that a more fruitful research avenue should escape the strong theoretical requirements of NNS models (e.g., equilibrium, rationality, representative agent, etc.) and consider the economy as a complex evolving system, i.e. as an ecology populated by heterogenous agents, whose far-from-equilibrium interactions continuously change the structure of the system. This is indeed the methodological core of agent-based computational economics (ACE), which is presented in this paper. We also discuss how ACE has been applied to policy analysis issues, and we provide a survey of macroeconomic policy applications (fiscal and monetary policy, bank regulation, labor market structural reforms and climate change interventions). Finally, we conclude by discussing the methodological status of ACE, as well as the problems it raises.