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Concept
Dynamic stochastic general equilibrium
Summary
Dynamic stochastic general equilibrium modeling (abbreviated as DSGE, or DGE, or sometimes SDGE) is a macroeconomic method which is often employed by monetary and fiscal authorities for policy analysis, explaining historical time-series data, as well as future forecasting purposes. DSGE econometric modelling applies general equilibrium theory and microeconomic principles in a tractable manner to postulate economic phenomena, such as economic growth and business cycles, as well as policy effects and market shocks.
As a practical matter, people often use the term "DSGE models" to refer to a particular class of econometric, quantitative models of business cycles or economic growth called real business cycle (RBC) models. Considered to be classically quantitative, DSGE models were initially proposed by Kydland & Prescott, and Long & Plosser; whereby Charles Plosser described RBC models as a precursor for DSGE modeling.
As mentioned in the Introduction, DSGE models constitute the predominant framework of macroeconomic analysis through their coherent combination of micro-foundations and optimising economic behaviour of rational agents. DSGE models are multi-faceted which allow for a more comprehensive analysis of macro effects, and their defining characteristics indicative through their name, are as follows:
Dynamic: The effect of current choices on future uncertainty makes the models dynamic and assigns a certain relevance to the expectations of agents in forming macroeconomic outcomes.
Stochastic: The models take into consideration the transmission of random shocks into the economy and the subsequent economic fluctuations.
General: referring to the entire economy as a whole (within the model) in that price levels and output levels are determined jointly. As opposed to a Partial equilibrium where price-levels are taken as given and only output-levels are determined within the model economy.
Equilibrium: Subscribing to the Walrasian, General Competitive Equilibrium Theory, the model captures the interaction between policy actions and subsequent behaviour of agents’.
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