Internal Consistency, Nominal Inertia and the Microfoundation of Macroeconomics (original) (raw)

An Important Inconsistency at the Heart of the Standard Macroeconomic Model

1998

Abstract: The standard neoclassical model is the foundation of most mainstream macroeconomics. Its basic structure dominates the analysis of macroeconomic phenomena, the teaching of the subject, and even the formation of economic policy. And of course the modern quantity theory of money and its attendant monetarist prescriptions are grounded in the model's strict separation between real and nominal variables.

The Trouble with Macroeconomics

In the last three decades, the methods and conclusions of macroeconomics have deteriorated to the point that much of the work in this area no longer qualifies as scientific research. The treatment of identification in macroeconomic models is no more credible than in the first generation large Keynesian models, and is worse because it is far more opaque. On simple questions of fact, such as whether the Fed can influence the real fed funds rate, the answers verge on the absurd. The evolution of macroeconomics mirrors developments in string theory from physics, which suggests that they are examples of a general failure mode of for fields of science that rely on mathematical theory in which facts can end up being subordinated to the theoretical preferences of revered leaders. The larger concern is that macroeconomic pseudoscience is undermining the norms of science throughout economics. If so, all of the policy domains that economics touches could lose the accumulation of useful knowledge that characteristic of true science, the greatest human invention.

The Classics, Keynes, and the Keynesians: A Unified Formalization

Eastern Economic Journal, 2017

We sketch a simple microfounded model that tries to capture the basic results of different macroeconomic schools by changing the values or behaviors of some parameter(s). The model has four different cases, which we label "Classical" (flexible prices and wages guaranteeing full employment), "Keynes' Liquidity Trap" (a shortage of demand incapable of being corrected even with wage or price deflation), "Sticky-Price Keynesian," and "Sticky-Wage Keynesian." We associate each of these instances of our model with "textbook cases," respectively: the labor-credit-money markets of the Classical case; Keynes-Krugman liquidity trap; the IS-LM model; and the AD-AS model.

Modern macroeconomics in practice: How theory is shaping policy

The Journal of Economic Perspectives, 2006

Theoretical advances in macroeconomics made in the last three decades have had a major influence on macroeconomic policy analysis. Moreover, over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The three key developments that have shaped macroeconomic policy analysis are the Lucas critique of policy evaluation due to Robert Lucas, the time inconsistency critique of discretionary policy due to Finn Kydland and Edward Prescott, and the development of quantitative dynamic stochastic general equilibrium models following Finn Kydland and Edward Prescott. _____________________________________________________________________________________ *We thank Kathy Rolfe and Joan Gieseke for excellent editorial assistance. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

Perspective on the current state of macroeconomic theory

International Journal of Systems Science, 1994

Historically, microeconomics was the domain of scientific methodology in economics, while macroeconomics attracted less mathematically oriented economists. In recent years, the level of sophistication of macroeconomics has grown dramatically, and that field now attracts many of the most mathematically oriented economists. Nevertheless, the field's set of shared views (i.e., maintained hypothesis) has not grown. The purpose of the scientific method is to permit the maintained hypothesis within a field to grow by establishing a rigorous methodology for deductively deriving and empirically testing hypotheses. The field of macroeconomics has failed that test of scientific success during precisely the decades of most rapid growth in the use of scientific methodology. It is argued that the source of the paradox lies in the fact that the inroads of science in macroeconomics have been asymmetric. Central to the definition and objectives of macroeconomics is dimension reduction and dynamics. Rigorous dimension reduction is impossible without formal aggregation, and complex dynamics is impossible without nonlinearity. Yet applications of formal aggregation theory and nonlinear dynamics to macroeconomics have progressed very slowly, at the time that scientific methodology in other areas of macroeconomics have advanced rapidly. This asymmetry explains the paradox.

On Model-Consistent Expectations in Macroeconomics

Económica, 2018

English: The practice of ascribing to agents expectations compatible with the model currently proposed by the analyst has been a widespread feature in Macroeconomics. However, that is a problematic assumption when used to depict anticipations constructed in the past since it would imply attributing to agents the use of a model that the economist had not yet built, and possibly not yet thought about. Thus, model- consistency is an ambiguous notion. In this paper we present a preliminary exploration of the application of the alternative forms of model-consistency in a very standard setup, using two related analytical constructs of different generations for U.S. data for the period 1959-2015.