Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 16 September 2016

Economics, DSGE and Reality: a personal story

As I do not win prizes very often, I thought I would use the occasion of this one to write something much more personal than I normally allow myself. But this mini autobiography has a theme involving something quite topical: the relationship between academic macroeconomics and reality, and in particular the debate over DSGE modelling and the lack of economics in current policymaking. [1]

I first learnt economics at Cambridge, a department which at that time was hopelessly split between different factions or ‘schools of thought’. I thought if this is what being an academic is all about I want nothing to do with it, and instead of doing a PhD went to work at the UK Treasury. The one useful thing about economics that Cambridge taught me (with some help from tutorials with Mervyn King) was that mainstream economics contained too much wisdom to be dismissed as fundamentally flawed, but also (with the help of John Eatwell) that economics of all kinds could easily be bent by ideology.

My idea that by working at the Treasury I could avoid clashes between different schools of thought was of course naive. Although the institution I joined had a well developed and empirically orientated Keynesian framework [2], it immediately came under attack from monetarists, and once again we had different schools using different models and talking past each other. I needed more knowledge to understand competing claims, and the Treasury kindly paid for me to do a masters at Birkbeck, with the only condition being that I subsequently return to the Treasury for at least 2 years. Birkbeck at the time was also a very diverse department (incl John Muellbauer, Richard Portes, Ron Smith, Ben Fine and Laurence Harris), but unlike Cambridge a faculty where the dedication to teaching trumped factional warfare.

I returned to the Treasury, which while I was away saw the election of Margaret Thatcher and its (correct) advice about the impact of monetarism completely rejected. I was, largely by accident, immediately thrust into controversy: first by being given the job of preparing a published paper evaluating the empirical evidence for monetarism, and then by internally evaluating the economic effects of the 1981 budget. (I talk about each here and here.) I left for a job at NIESR exactly two years after I returned from Birkbeck. It was partly that experience that informed this post about giving advice: when your advice is simply ignored, there is no point giving it.

NIESR was like a halfway house between academia and the Treasury: research, but with forecasting rather than teaching. I became very involved in building structural econometric models and doing empirical research to back them up. I built the first version of what is now called NIGEM (a world model widely used by policy making and financial institutions), and with Stephen Hall incorporated rational expectations and other New Classical elements into their domestic model.

At its best, NIESR was an interface between academic macro and policy. It worked very well just before 1990, where with colleagues I showed that entering the ERM at an overvalued exchange rate would lead to a UK recession. A well respected Financial Times journalist responded that we had won the intellectual argument, but he was still going with his heart that we should enter at 2.95 DM/£. The Conservative government did likewise, and the recession of 1992 inevitably followed.

This was the first public occasion where academic research that I had organised could have made a big difference to UK policy and people’s lives, but like previous occasions it did not do so because others were using simplistic and perhaps politically motivated reasoning. It was also the first occasion that I saw close up academics who had not done similar research but who had influence use that influence to support simplistic reasoning. It is difficult to understate the impact that had on me: being centrally involved in a policy debate, losing that debate for partly political reasons, and subsequently seeing your analysis vindicated but at the cost of people becoming unemployed.

My time at NIESR convinced me that I would find teaching more fulfilling than forecasting, so I moved to academia. The publications I had produced at NIESR were sufficient to allow me to become a professor. I went to Strathclyde University at Glasgow partly because they agreed to give temporary funding to two colleagues at NIESR to come with me so we could bid to build a new UK model. [3] At the time the UK’s social science research funding body, the ESRC, allocated a significant proportion of its funds to support econometric macromodels, subject to competitions every 4 years. It also funded a Bureau at Warwick university that analysed and compared the main UK models. This Bureau at its best allowed a strong link between academia and policy debate.

Our bid was successful, and in the model called COMPACT I would argue we built the first UK large scale structural econometric model which was New Keynesian but which also incorporated innovative features like an influence of (exogenous) financial conditions on intertemporal consumption decisions. [4] We deliberately avoided forecasting, but I was very pleased to work with the IPPR in providing model based economic analysis in regular articles in their new journal, many written with Rebecca Driver.

Our efforts impressed the academics on the ESRC board that allocated funds, and we won another 4 years funding, and both projects were subsequently rated outstanding by academic assessors. But the writing was on the wall for this kind of modelling in the UK, because it did not fit the ‘it has to be DSGE’ edict from the US. A third round of funding, which wanted to add more influences from the financial sector into the model using ideas based on work by Stiglitz and Greenwald, was rejected because our approach was ‘old fashioned’ i.e not DSGE. (The irony given events some 20 years later is immense, and helped inform this paper.)

As my modelling work had always been heavily theory based, I had no problem moving with the tide, and now at Exeter university with Campbell Leith we began a very successful stream of work looking at monetary and fiscal policy interactions using DSGE models. [5] We obtained a series of ESRC grants for this work, again all subsequently rated as outstanding. Having to ensure everything was microfounded I think created more heat than light, but I learnt a great deal from this work which would prove invaluable over the last decade.

The work on exchange rates got revitalised with Gordon Brown’s 5 tests for Euro entry, and although the exchange rate with the Euro was around 1.6 at the time, the work I submitted to the Treasury implied an equilibrium rate closer to 1.4. When the work was eventually published it had fallen to around 1.4, and stayed there for some years. Yet as I note here, that work again used an ’old fashioned’ (non DSGE) framework, so it was of no interest to journals, and I never had time to translate it (something Obstfeld and Rogoff subsequently did, but ignoring all that had gone before). I also advised the Bank of England on building its ‘crossover’ DSGE/econometric model (described here).

Although my main work in the 2000s was on monetary and fiscal policy, the DSGE framework meant I had no need to follow evolving macro data, in contrast to the earlier modelling work. With Campbell and Tatiana I did use that work to help argue for an independent fiscal council in the UK, a cause I first argued for in 1996. This time Conservative policymakers were listening, and our paper helped make the case for the OBR.

My work on monetary and fiscal interaction also became highly relevant after the financial crisis when interest rates hit their lower bound. In what I hope by now is a familiar story, governments from around the world first went with what macroeconomic theory and evidence would prescribe, and then in 2010 dramatically went the opposite way. The latter event was undoubtedly the underlying motivation for me starting to write this blog (coupled with the difficulty I had getting anything I wrote published in the Financial Times or Guardian).

When I was asked to write an academic article on the fiscal policy record of the Labour government, I discovered not just that the Coalition government’s constant refrain was simply wrong, but also that the Labour opposition seemed uninterested in what I found. Given what I found only validated what was obvious from key data series, I began to ask why no one in the media appeared to have done this, or was interested (beyond making fun) in what I had found. Once I started looking at what and how the media reported, I realised this was just one of many areas where basic economic analysis was just being ignored, which led to my inventing the term mediamacro.

You can see from all this why I have a love/hate relationship to microfoundations and DSGE. It does produce insights, and also ended the school of thought mentality within mainstream macro, but more traditional forms of macromodelling also had virtues that were lost with DSGE. Which is why those who believe microfounded modelling is a dead end are wrong: it is an essential part of macro but just should not be all academic macro. What I think this criticism can do is two things: revitalise non-microfounded analysis, and also stop editors taking what I have called ‘microfoundations purists’ too seriously.

As for macroeconomic advice and policy, you can see that austerity is not the first time good advice has been ignored at considerable cost. And for the few that sometimes tell me I should ‘stick with the economics’, you can see why given my experience I find that rather difficult to do. It is a bit like asking a chef to ignore how bad the service is in his restaurant, and just stick with the cooking. [6]

[1] This exercise in introspection is also prompted by having just returned from a conference in Cambridge, where I first studied economics. I must also admit that the Wikipedia page on me is terrible, and I have never felt it kosher to edit it myself, so this is a more informative alternative.

[2] Old, not new Keynesian, and still attached to incomes policies. And with a phobia about floating rates that could easily become ‘the end is nigh’ stuff (hence 1976 IMF).

[3] I hope neither regret their brave decision: Julia Darby is now a professor at Strathclyde and John Ireland is a deputy director in the Scottish Government.

[4] Consumption was of the Blanchard Yaari type, which allowed feedback from wealth to consumption. It was not all microfounded and therefore internally consistent, but it did attempt to track individual data series.

[5] The work continued when Campbell went to Glasgow, but I also began working with Tatiana Kirsanova at Exeter. I kept COMPACT going enough to be able to contribute to this article looking at flu pandemics, but even there one referee argued that the analysis did not use a ‘proper’ (i.e DSGE) model.

[6] At which point I show my true macro credentials in choosing analogies based on restaurants.  


  1. Nice piece but this is the correct link to the prize I think

    Thoroughly deserved.

    1. Whoops - still not got the hang of this blogging thing! Thanks.

  2. Well done Simon! I enjoy the blog very much and we enjoyed hosting you at the RBNZ in 2004.

  3. "Proscribe" looks like a typo. I think you mean prescribe.

  4. A lovely and informative piece, Simon. Congratulations on the award. If only more scholars were equally self-reflective.

  5. Two points that Romer makes that your heterodox and non-economist irritators have made since, well probably your blog began. In fact we could not have put it more clearly ourselves. And these are the two critical points that I am sure we would all like to know your position on:

    "all models are false" seems to have become the universal hand-wave
    for dismissing any fact that does not conform to the model that is the current favorite"


    "Math cannot establish the truth value of a fact. Never has. Never will."

    These are very self-evident to historians, psychologists and most educated people. But for some reason economists have a lot of problems with them. The point is not about changing Model. It is about thinking outside Model and engaging with other disciplines. It means working with real information which might be entirely non-quantitative and not suitable for modelling. The question is no longer 'what is the model'.

    Basically it means that to break the impasse, economics needs to be taken back something it looked like before Samuelson 1948.

    It is not about the model. It is about understanding what actually goes on.


    1. I find this a strange critique. Of course models are false to some degree, but we only need them to be meaningful and insightful for the task at hand. Maths is just a short-hand for describing the forces at play. There are good models and there are bad models; the latter don't invalidate the former. Where I would agree is that economists need to read widely, including from economic historians and themes from other social sciences. They should be able to justify their thinking in words, ideally in an accessible way for non-economists (our blogger provides a fantastic guide - congrats, Simon!). But being able to translate their thinking into a concise model is a virtue, not a sin. It's a great way to check verbal reasoning is internally consistent and can sometimes unearth unexpected predictions that warrant investigation. A classic example of the latter is Krugman's Japan paper of 1998. So I'm sorry NK, but I can't agree economists should ditch modelling.

    2. There are of course cases where a model is useful. And of course we use them for estimates in policy making. But as Romer makes very clear, they cannot substitute as an explanation for the factual details of what happens.

      The causes of the problems in Japan and Krugman's paper is a good example - and these causes are not discussed anywhere properly in Krugman's paper. There were already very good books and articles (written by Japanese experts not in economics departments who could read the even better literature in Japanese) discussing the causes of the liquidity trap in Japan: these had to do with these like financial restructuring after the crash and the situation of a large amount of liquidity chasing few safe assets. I know, I remember reading it myself. Traditionally in the Main Bank System, banks tied to specific corporations; these banks were forced to amalgamate which led to fewer banks in the system and the ones that remained were left chasing fewer clients.

      This is a critical part of the complex story of what happened. None of this is discussed in Krugman's paper, or it is speculatively done so with little documentary evidence. Predictably he did not feel the need to consult the Japanese who knew what was really going on. He never went to get information from borrowers and lenders or cite people who have done this to find out what they did and why. When he does think outside model and try to understand what might actually happened he says things like "media reports suggests" - without even citing the reports! Why? Because the only thing he thinks is important is the model! In fact that paper is centred around ISLM and Representative Agent model, with very little given to what was going on in Japan. ISLM models and Representative agent models tell us about ISLM and Representative agent models - not what we want to know.

      The real story here is not in ISLM or Representative Agent models.

      Again, it is not about what model. To understand the causal mechanism, you have to know what exactly happened. This requires that you build up the picture from documentary evidence - much of it will be non-quantitative. Models are a distraction. You will see what you want to see with a model. But you have missed the most important part of the story - the factual detail. Models may serve as a reference point, but that's it.

  6. But not as wrong as Paul Krugman …


  7. Well-deserved. I've learnt a lot from your blog

  8. Well deserved Simon. Your blog is truly excellent. Interested in any further reflections on leaving HMT, where you have said 'when your advice is simply ignored there is no point giving it'. Presumably you think then that you have had more impact from leaving, compared to staying and becoming more influential? And what advice would you give to those starting their careers in a similar position to you were in late 70's and early 80's? Cheers.

  9. "In what I hope by now is a familiar story, governments from around the world first went with what macroeconomic theory and evidence would proscribe,"

    I hesitate to correct an Oxford Professor, but I think you may mean 'prescribe' as the distinction is rather significant in this context.

    The whole article very enlightening and I certainly had not realised you were such a DSGE rebel (but then I had 30 years off from any contact with academic economics).

  10. After all this if you were starting all over again thinking what is the best thing I can do to influence policy for the better, what would you have gone into?

  11. And it's surely prescribe you mean not proscribe.

  12. A very interesting and relevant post. I am afraid recent events are unlikely to be the last time informed advice will be ignored. Indeed we seem to be moving into an time of greater irrationality.

    Apart from powerful institutions or individuals the only thing political leaders respond to is public opinion and our only hope is a better informed public. In regard to economic issues this I think would have to involve some understanding , in simple terms , of the multiplier effect of increasing public borrowing and the likely size of that multiplier.

    We took it for granted when I did elementary economics years ago but you do not hear much discussion of the multiplier in any detail even from strong advocates of anti austerity. Do you think anything could be done about this ?

  13. So basically, we your readers should all be very happy that the rest of the world ignores you. :-)

  14. Congratulations Simon. Well deserved!

  15. DSGE is Dynamic Stochastic General Equilibrium. Which of those 4 deserves your hate the most?

    1. None, unless they imply that everything has to be D,S or GE. But DSGE is really a label for the necessity that models be internally consistent, and that necessity I do object to because it (inevitably) comes at the cost of empirical relevance.

    2. Simon,

      Have you not just stepped into a minefield?

      So what parts do you keep, what parts do you jetison?

      Is it still d, s and deal with ge? (All purposely lower case.)


    3. Yes. No more telling sentence than this one: "Although my main work in the 2000s was on monetary and fiscal policy, the DSGE framework meant I had no need to follow evolving macro data, in contrast to the earlier modelling work." There is a lot of work out there, published and much admired, that has little relation to reality as defined by the data.

  16. I'm still not quite sure I understand your insistence that macro modeling indicates the benefits of stimulus. In a simple ZLB-based model, what matters is government spending *today* (during the trap, when we're constrained) relative to government spending *immediately after the trap*.

    So the key, at least as far as the models are concerned, is really the downward slope of the time path of government spending, not its level. It seems, therefore, that you should equally be advocating (1) an increase in government spending during the trap, and (2) a commitment to a decrease in government spending as we leave the trap. But in practice it seems you mainly advocate (1), and sometimes you even seem to advocate the opposite of (2) - critiquing fiscal austerity even when it's mainly making cuts after the trap is over.

    I acknowledge that the symmetry between "raise spending today" and "cut spending tomorrow" may be an artifact of crude forward-looking macro models. But it doesn't rely on a particularly objectionable form of rational expectations - the expectations work mainly through financial markets, with lower government spending in the future lowering expectations of future interest rates and thus long-term yields. So why don't you ever address this point?

    1. If you look at what I have written it is always the two stage process you describe. When have I argued the opposite of (2)? I have always stressed that you deal with the deficit after you safely leave the ZLB.

    2. I think the problem is the "safely leave the ZLB" view. The theory says, more or less, that you want to cut spending *in the region where you're leaving the ZLB*.

      (At the margin, the theory in its starkest form says that what matters is the level of government spending at exactly the point where you're leaving the ZLB. But let's smooth this out and say that in practice what matters is some interval around this.)

      Waiting to cut until you've "safely" left the ZLB, i.e. where it's completely clear that you won't have to go back to the ZLB, isn't useful for stimulative purposes - at least according to the basic ZLB model. That's why I'm a little skeptical of your view that you're relying on the model and that others are ignoring it.

  17. Congratulations! Thoroughly deserved.

    Policy would would be a lot better if economists like you were taken even more seriously more broadly.

    Personally, despite an acute discomfort with the DSGE methodology,you are one of the very few DSGE modellers I take very seriously. Though my conviction is that it is not your choice of methodology but rather your wide ranging knowledge, sensitivity to empirical evidence, and flexible and open-minded outlook that all make you a genuinely impressive macroeconomist.

  18. Prof. Wren-Lewis,

    You learned at a tender age that economics can succumb to ideology. So, why did you succumb?

    Of course, that brought you the prize. The members of the New Statesman jury were certainly delighted to have an Oxford professor who is an engaged supporter of Labour.

    Or perhaps they liked your use of words:

    (In the financial crisis) "governments from around the world first went with what macroeconomic theory and evidence would proscribe", in other words reject, oppose, denounce, disapprove of and want to kill off.

    1. Can you show me a single aspect of my economics that is influenced by ideology? I have no idea about what you are trying to say from my quote.

    2. Mainly Macro17 September 2016 at 03:47

      "Can you show me a single aspect of my economics that is influenced by ideology?"

      No trouble - just read some of the critical comments to your blog in tha past years.

      Your remark shows that your faculty for self-deception is unsurpassed. Ideology is, according to a famous definition, false consciousness. And your relationship to reality is seriously disturbed.

      And it seems you don't understand the English word "proscribe" in spite of the comments above trying to put you right. It means "reject, oppose, denounce, disapprove of and want to kill off."

      Of course, if you always mean the contrary of what you write, you have deserved the prize.

    3. Hope you're ignoring the trolls Simon; some of the comments like the above are really unbelievable (I guess Anon really showed that he had zero examples of ideology and had to resort to ad-hominem attacks, but still managed to insult you in the process!)

      Congrats on the prize - I really enjoy your blog, hope you keep it going! :) (from an econ PhD student)

    4. "No trouble - just read some of the critical comments to your blog in tha past years."

      That's a cop out. Find something to back up your claim, else stop trolling. And the proscribe vs prescribe jibe is just petty.

    5. Of course it's petty to proscribe illiteracy - one should prescribe it.

  19. Although my rare appearances here have almost always involved me disagreeing with or criticizing arguments you have made, I congratulate on your well-deserved award. Your account here of your own intellectual and career development is most informative and interesting. Keep up the good work.

    Barkley Rosser

  20. Many thanks for the personal history which I found interesting and enjoyable.

  21. Any idea with Stiglitz and Greenwald work never took off with others? I find it both very relevant and refreshing (eg. focus on credit, skeptical of interest rate channel...)

  22. Congratulations Prof Wren-Lewis

  23. Hello Simon, Congratulations for your prize, certainly most deserved. Re your post, I don't quite see what your take-away is from the specification/identification critique of Paul Romer is on DSGE modelling and estimation/calibration. Could you say a word on this issue? Can't a Stuctural Econometric Model be as internally consistent than DSGEs, and more transparent than DSGEs (without the need to turn to what Romer calls the "hidden FWUTVs"?)

  24. The trouble with economics prizes
    Comment on Simon Wren-Lewis on ‘Economics, DSGE and Reality: a personal story’

    The trouble with economics prizes begins here: “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”.

    The key word is science[s]. Why not simply “Bank of Sweden Prize in Economics”? The original title clearly communicates the claim that economics is a science. This claim is as old as Adam Smith/Karl Marx. But economists never lived up to the claim.

    Science is well-defined by the criteria of formal and material consistency: “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994)

    Neither orthodox nor heterodox economics satisfies the criteria of formal and material consistency. Worse, economists violate scientific standards since the founding fathers. There is no exception: Walrasian, Keynesian, Marxian, or Austrian economics is provable inconsistent.

    There is political economics and theoretical economics. The founding fathers were straightforward people and called themselves political economists, that is, they left no doubt that their main business was agenda pushing. Economics never really got out of political economics. In other words, theoretical economics (= science) ultimately could not fully emancipate itself from political economics (= agenda pushing). How economics became one of the most embarrassing failures in the history of scientific thought requires a more detailed account.

    Standard economics is built upon this set of foundational propositions, a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub 1985)

    Methodologically, these premises are forever unacceptable but economists swallowed them hook, line and sinker from Jevons/Walras/Menger onward to DSGE. The failure of methodological individualism is indisputable. The ultimate reason can be stated as an impossibility theorem: NO way leads from the explanation of individual behavior to the explanation of how the economic system works.

    Because of this, the microfoundations approach has already been dead in the cradle. Methodologically, this leaves only one option. As Joan Robinson put it: “Scrap the lot and start again.”

    Keynes started the macrofoundations research program in the General Theory formally as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (p. 63)

    These formal foundations are conceptually and logically defective because Keynes never came to grips with profit and therefore “discarded the draft chapter dealing with it.” (Tómasson et al., 2010)

    Keynes’s original blunder kicked off a chain reaction of errors/mistakes. As a result, all I=S/IS-LM models are worthless. Most importantly, Keynes’s profit conundrum remained unsolved. Until this day neither Walrasians, nor Keynesians, nor Marxians, nor Austrians got profit right. As the Palgrave puts it: “A satisfactory theory of profits is still elusive” (Desai). Because economist have no idea of the pivotal concept of their subject matter they cannot explain how the actual economy works. No doubt, economists bear the intellectual responsibility for the social devastations of the Great Depression and other economic crises since then. Economic policy guidance never had a sound scientific foundation. Why are economists awarded prizes and not simply thrown out of science because of manifest incompetence?

    Egmont Kakarot-Handtke

  25. Congratulations!
    I, being a member of the public without economics training, always find that your posts have explained economic issues in public policy to me in a very clear way and have given me a certain understanding of them I otherwise certainly would have lacked.
    Indeed, unfortunately, much more so than if I had just read the papers.

  26. Congratulations Simon! It is very well deserved.

    As a lay person, you are my "go to" source on UK economics.

  27. Congratulations on a well deserved award.

    Your blog matters a lot to non-economists like me.

  28. Thanks, its interesting to hear your perspective on how economic methodology was influencing policy decisions. I have two questions:

    (1) You describe those methodological shifts much like changes in taste but I feel this is unfair. The Lucas Critique is the key reason why journals/academia have become adamant on micro founded models. Did the Lucas Critique not influence you (e.g. in your move to New Keynesian work with Campbell and Kirsanova) ? The above reads like you were under academic duress.

    (2) DSGE models are often lampooned as models requiring extreme and unrealistic assumptions. But they are extremely general, from textbook new Keynesian models to highly non-linear models of heterogeneous agents with financial frictions and beyond. They are just models with equilibrium between sectors (GE), where that equilibrium is perturbed by shocks (S) and the results describe the response of the economy over time (D). Those are very reasonable aspects to require of any macroeconomic model. This framework would permit a researcher to build almost anything they want. To my knowledge, almost all DSGE models in the macro lit assume micro foundations but hasn't this got more to do with (1) than the constraints of D,S and GE?

  29. Very interesting blog. I loved:

    "It was also the first occasion that I saw close up academics who had not done similar research but who had influence use that influence to support simplistic reasoning"

    Also as a former student of Birkbeck economics dept i would recommend them to anyone for their commitment to teaching.


Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time. In addition, I cannot publish comments with links to websites because it takes too much time to check whether these sites are legitimate.