Dynamic Stochastic General Equilibrium (DSGE) models are a class of macroeconomic models that capture the behavior of an economy over time while considering the impact of random shocks. These models are built on the principles of general equilibrium, meaning they account for the interdependencies of various markets and agents within the economy. They incorporate dynamic elements, which reflect how economic variables evolve over time, and stochastic aspects, which introduce uncertainty through random disturbances.
A typical DSGE model features representative agents—such as households and firms—that optimize their decisions regarding consumption, labor supply, and investment. The models are grounded in microeconomic foundations, where agents respond to changes in policy or exogenous shocks (like technology improvements or changes in fiscal policy). The equilibrium is achieved when all markets clear, ensuring that supply equals demand across the economy.
Mathematically, the models are often expressed in terms of a system of equations that describe the relationships between different economic variables, such as:
Yt=Ct+It+Gt+NXt
where Yt is output, Ct is consumption, It is investment, Gt is government spending, and NXt is net exports at time t. DSGE models are widely used for policy analysis and forecasting, as they provide insights into the effects of economic policies and external shocks on