A note on Dynamic Stochastic General Equilibrium Models(DSGE).

A brief overview.

Before we talk about DSGE models, we need to first talk about macroeconomics. Macroeconomics is simply a way of understanding the behavior and performance of the economy as a whole.¹

A DSGE model is a method in macroeconomics that incorporates the evolution of economy, random shocks(like COVID-19) to economy, and general equilibrium theory. As per Wikipedia, “DSGE models share a structure built around three interrelated “blocks”: a demand block, a supply block, and a monetary policy equation. Formally, the equations that define these blocks are built on microfoundations and make explicit assumptions about the behavior of the main economic agents in the economy, i.e. households, firms, and the government.”

Algorithm to solve DSGE model in general²:

The algorithm for solving dynamic stochastic general equilibrium
(DSGE) models generally consists of the following steps:
Step 1. Derive the first-order conditions of the model.
Step 2. Find the steady state.
Step 3. Linearize the system around the steady state.
Step 4. Solve the linearized system of equations (i.e. decision rules
for jump variables and laws of motion for state variables).

I will leave the details of the equations in the references².