What is so hard about disequilibrium dynamics?

(written by lawrence krubner, however indented passages are often quotes). You can contact lawrence at: lawrence@krubner.com, or follow me on Twitter.

This is a throwaway line by Paul Krugman:

What are the alternatives? One — which took over much of macro — is to do intertemporal equilibrium all the way, with consumers making lifetime consumption plans, prices set with the future rationally expected, and so on. That’s DSGE — and I think Glasner and I agree that this hasn’t worked out too well. In fact, economists who never learned temporary-equiibrium-style modeling have had a strong tendency to reinvent pre-Keynesian fallacies (cough-Say’s Law-cough), because they don’t know how to think out of the forever-equilibrium straitjacket.

What about disequilibrium dynamics all the way? Basically, I have never seen anyone pull this off. Like the forever-equilibrium types, constant-disequilibrium theorists have a remarkable tendency to make elementary conceptual mistakes.

In short, Hicks was a very smart guy — his method often seems to hit a sweet spot between rigorous irrelevance and would-be realism that ends up being just confused.

In some sense, we know that Disequilibrium Forever is the truth — markets are never at equilibrium. But if they are the truth, don’t we lose something crucial if we are unable to model them? Don’t we lose something when we use equilibrium models? But the math of equilibrium models is easier, so we go with that.

I’m reminded of the emergence of chaos theory in the 1950s and 1960s. For over a century, chaos was kept out of models as this crazy edge case that ruined the purity of engineering models (in situations like fluid disturbance). And then Chaos Theory emerged, and chaos became a thing that we modeled. I wonder if something similar will one day happen with disequilibrium dynamics?

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