## G8 or G20 Protests and Computable General Equilibrium (CGE) modelling and its Dual Instability Problem

This article discusses why *Computable General Equilibrium* (CGE) models are important to the G8 or G20 protests and why CGE models are unsuitable for policy analysis for the following two reasons, CGE lacking microfoundations and the dual instability problem.

First, why are CGE models important to the G8 or G20 protests? An example of a global CGE model is the *Global Trade Analysis Project* (GTAP 2009) coordinated by the Centre for Global Trade Analysis, Department of Agricultural Economics, Purdue University. GTAP (2009) claims that their model provides a common language for global economic analysis; they cite the use of GTAP in three of the five quantitative studies at the 1995 conference of the WTO’s Uruguay Round Agreement and in virtually all the quantitative work for the 1999 Millennium Round of Multilateral Trade. This example indicates the credibility and perceived importance of CGE.

Regarding CGE lacking microfoundations, the *‘general equilibrium’* of CGE models comes from balancing macro Keynesian simultaneous equations, in which equilibrium is imposed from above that makes CGE models *‘top–down’* models, which makes the *‘general equilibrium’* of CGE models an assumption. In comparison, the *‘general equilibrium’* of the *Applied General Equilibrium* (AGE) and *General Equilibrium Theory* (GET) of the *Arrow–Debreu–McKenzie *(ADM) models derives from finding a prices vector that balances the supply and demand of the agents, where equilibrium is calculated, thus AGE and ADM models are *‘bottom–up’* models and seek to provide proof of *‘general equilibrium’*. However, my post *‘The G8 protests and the logically inconsistent foundations of neoclassical economics’* discusses how these *‘bottom–up’ *models lack microfoundations because they failed to find a stable price vector that is *‘general equilibrium’* hence these models and neoclassical economics are built on theoretically inconsistent foundations or axioms.

In addition to CGE lacking microfoundations, the validity of imposing equilibrium as a *‘top–down’* model is also questionable. Blatt (1983) discusses the dual (in)stability problem in an accelerator-multiplier model that is a version of the *‘top-down’* models used in CGE, where the multiplier v can take the values 0 < v < 1 or v > 1. If v > 1, there are endogenous trade cycles but the long-run equilibrium is unstable (explosive). If 0 < v < 1, the long-run equilibrium is stable but there lacks endogenous trade cycles. A solution to this dilemma is to assume that all trade cycles are the result of exogenous shocks. However, this assumption contradicts empirical evidence. Blatt (1983) concludes that equilibrium analysis is unreliable and ineffective for understanding or developing policies to mitigate the severity of trade cycles. Equilibrium analysis is a core concept in neoclassical economics and its CGE models.

Furthermore, despite these findings, the basic CGE model is extended, while retaining the assumption that all trade cycles are the result of exogenous shock, to form the *Dynamic Stochastic General Equilibrium Models* (DSGE) to study trade cycles. The first of these DSGE models is known as the *Real Business Cycle* (RBC) that is discussed in my post *‘Real Business Cycle (RBC) and Rational Expectations Hypothesis (REH) contributing to the Global Financial Crisis (GFC) and the Dynamite Prizes‘*.

The EU acknowledges the failure of traditional economics that is neoclassical economics and are introducing Agent-based modelling, see my posts *‘EU acknowledges the failure of traditional economics to predict so adopts agent based modelling’ *and* ‘Progressing from game theory to agent based modelling to simulate social emergence‘.*

In addition to CGE, the neoclassical ideology affects peoples’ worldview in a number of ways, for a financial perspective see my post *‘Capital Asset Pricing Model (CAPM) and Efficient Market Hypothesis (EMH) Contributing to the Global Financial Crisis (GFC)’* and for a political perspective see my post *‘Comparing the role of government in self-control problems from behavioural and neoclassical economic perspectives’.* The website *‘Toxic Textbooks’* further discusses how the neoclassical ideology is indoctrinated via the university education system to permeate financial and political systems.

The ideas discussed in this article are taken from and elaborated in *Adaptive Interactive Expectations.*

**References**

<About> <Portfolio> <Academia> <LinkedIn> <Twitter> <Blog>

[…] of the TTIP’s effects. Projections by different institutions have been shown to rely on the same Computable General Equilibrium model that has proved to be inadequate as a tool for trade p…, ‘lacking microfoundations and the dual instability […]

A new twist in the TTIP saga | Political Concern2015 February 8 at 5:19 am

[…] of the TTIP’s effects. Projections by different institutions have been shown to rely on the same Computable General Equilibrium model that has proved to be inadequate as a tool for trade p…, ‘lacking microfoundations and the dual instability […]

Jeronim Capaldo (Tufts Un.) says that, “Evaluated with the United Nations model, TTIP appears to favor economic dis-integration, rather than integration, in Europe. At a minimum, this shows that official studies do not offer a solid basis for an inf2015 February 10 at 11:55 pm

[…] of the TTIP’s effects. Projections by different institutions have been shown to rely on the same Computable General Equilibrium model that has proved to be inadequate as a tool for trade p…, ‘lacking microfoundations and the dual instability […]

Jeronim Capaldo (Tufts Un.) says that, “Evaluated with the United Nations model, TTIP appears to favor economic dis-integration, rather than integration, in Europe. At a minimum, this shows that official studies do not offer a solid basis for an inf2015 February 10 at 11:55 pm