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Sebastian Dullien

The paper discusses the merits and risks of heterodox economists using mainstream economic models, and especially dynamic stochastic general equilibrium (DSGE) models, to promote economic policy conclusions usually found in post-Keynesian economic thought such as large fiscal multipliers, importance of distributional issues for macroeconomic stability, and the role of endogenous money creation for the explanation of economic downturns after a banking crisis. It argues that using these models can help heterodox researchers to communicate with mainstream economists and might help to further one's personal academic career, but that such a strategy comes along with the risk of having to accept other, very questionable policy conclusions and of stabilizing the use of the DSGE models in mainstream economics, hence potentially delaying a Kuhnean-type ‘scientific revolution’ in macroeconomics.

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Sebastian Dullien

In standard macroeconomic models (new classical, AS-AD, monopolistic competition etc.) monetary policy determines the price level. Output and employment are determined in the labour market where nominal wages are set (possibly under the influence of unions), which together with the price level yield real wages. This paper shows that including nominal wages instead of real balances in the aggregate demand function of a standard monopolistic competition model changes this conclusion completely. In a model with micro-founded investment decisions, wage setters now control the price level. Monetary policy determines output and employment. Neither actor can influence real wages and profits, which are determined by the degree of monopolisation. Further, this conclusion fits well the stylised facts of the Euro area and provides an explanation for high unemployment in Europe.

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Sebastian Dullien

The paper develops a three-asset-portfolio model to analyse consequences of foreign exchange market operations by Asian central banks on the exchange rates between euro, dollar and an Asian currency. It is found that – contrary to public belief – the purchase of dollar assets by Asian central banks strengthens the dollar against both the euro and the Asian currency. A diversification of Asian central bank reserves from dollar into euro would weaken the dollar against both other currencies. Thus, such a diversification would be incompatible with Asian currency pegs. However, it is shown that Asian central banks could alter their relative portfolio composition while keeping the peg intact if they shifted from intervening against the dollar into intervening against the euro.

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Sebastian Dullien

The paper traces the treatment of fiscal policy in mainstream Keynesian models, from IS-LM over simple dynamic New Keynesian models to the most sophisticated New Keynesian dynamic stochastic general equilibrium (DSGE) models and compares it with stylized empirical facts on the impact of fiscal policy. It is found that the traditional simple Keynesian models such as IS-LM and Mundell–Fleming actually come to very similar conclusions on the effectiveness of fiscal policy as the most complex DSGE models, and are very much in line with stylized empirical facts found in most recent studies. In contrast, the dynamic models used during most of the 1990s and 2000s perform very poorly. It is hence questioned whether the change in modeling approaches over the past 60 years really constitutes progress in economic insight given the growing complexity of modern models.

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Sebastian Dullien

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Editorial

The state of economics after the crisis

Edited by Sebastian Dullien, Eckhard Hein and Till van Treeck