An essay on the history of DSGE models

TL;DR

This paper reviews the historical development of DSGE models, highlighting their mathematical foundations, evolution from earlier theories, and the implications of their adoption by central banks, emphasizing a shift from universal to context-specific modeling.

Contribution

It provides a comprehensive historical overview of DSGE models, connecting economic theories with mathematical tools, and discusses the implications of their recent use by central banks.

Findings

DSGE models evolved from Neoclassical theories and mathematical advancements.

The New Neoclassical Synthesis unified different economic theories.

Central banks' adoption of DSGE models has shifted focus from universal to context-specific applications.

Abstract

Dynamic Stochastic General Equilibrium (DSGE) models are nowadays a crucial quantitative tool for policy-makers. However, they did not emerge spontaneously. They are built upon previously established ideas in Economics and relatively recent advancements in Mathematics. This essay provides a comprehensive coverage of their history, starting from the pioneering Neoclassical general equilibrium theories and eventually reaching the New Neoclassical Synthesis (NNS). In addition, the mathematical tools involved in formulating a DSGE model are thoroughly presented. I argue that this history has a mixed nature rather than an absolutist or relativist one, that the NNS may have emerged due to the complementary nature of New Classical and New Keynesian theories, and that the recent adoption and development of DSGE models by central banks from different countries has entailed a departure from the goal of building a universally valid theory that Economics has always had. The latter means that DSGE modeling has landed not without loss of generality.