Comment of the Day: Robert Waldmann: Monday Smackdown: Oh Dear!: "I object to another word in the sentence—'only'"...
...I will modify it to answer your objection: "The only place that we can do [thought] experiments is in dynamic stochastic general equilibrium (DSGE) models." The assertion is that all models are general equilibrium models.
Now back when I was a student, general equilibrium models were Walrasian models with price taking agents. Perfect competition was one of the assumptions. That's what the phrase meant. Now the equilibrium which is general is Nash equilibrium. Imperfect competition is a standard assumption. The triumph of imperfect competition was the Eichenbaum, Cristiano and Evans model and it was a triumph because it meant that people who worked next to great lakes had admitted that people who worked nearer to the Atlantic Ocean were more nearly correct.
But nothing has ever supported the argument that anything is gained by assuming the world is in Nash equilbrium. There are two problems. By itself the assumption of Nash equilibrium implies nothing at all—it can't impose discipline on our theory. Only if you require plausible assumptions about tastes and technology does it imply anything. Yet, standard models have confessedly implausible assumptions. It is argued that it is necessary to assume Nash equilibrium to impose discipline but fine to assume things which are absurd and contradicted by micro data. The arguments are opposite. Not only is it impossible for them both to be true, it is impossible for both to be false.
Longer rant here: http://rjwaldmann.blogspot.it/2012/03/modern-macroeconomic-methodology-modern.html
The history of efforts to base macro on Nash equilibrium is, as our host Brad notes, what one would expect from a fundamentally misguided research project. With great effort you can make the new improved models behave like the old models. Once this is achieved, nothing at all has been gained. The hope might be that once the model is fiddled to fit 10 aspects of old Keynesian models (now considered stylized facts not proper good economic DSGE models) then it will fit the 11th. This is what happens in a nondegenerative reasearch program. But consistently, the new high brow high tech DSGE models require one fiddle factor for every moment of the data they match. This is what happens when one's approach is worthless and one's core assumptions are false.
Also, all macroeconomists I know agree with all of this.
