325_Lecture17_April4 - A BRIEF HISTORY OF...

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1 AB RIEF H ISTORY OF M ACROECONOMICS (CONTINUED) A PRIL 4, 2011 April 4, 2011 2 T HE F ALL OF M ACROECONOMICS The Evolution of Macroeconomics: Phase II ± Big “Keynesian macroeconometric” models prominent by the 1960’s, led by ± Kennedy’s Council of Economic Advisers (Solow, Tobin, Samuelson) ± MIT/Penn/Federal Reserve Board ± ISLM and AS/AD model (Hicks, 1937) the conceptual core ± Became widely used for policy-making… ± …until they “stopped working” in the 1970’s ± Amidst a high-inflation environment (U.S. inflation between 15-20% in second half of 1970’s), sparked by OPEC oil embargoes ± Lucas Critique (1976): The alpha’s themselves should be thought of / modeled as functions of government policy! 123 21 4 012 34 5 5987 5988 5 136 1 98 3 13 9 69 3 .... ... ... tt t t t t t t xxx xx x x x x x D DD DDD ±±± # Dozens or hundreds of variables and equations, some of which describe how policy affects the economy Say x 3 and x 13 are policy variables General idea of Keynesian-inspired macroeconometric models One of these equations is the Phillips Curve
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2 April 4, 2011 3 T HE L UCAS C RITIQUE The Evolution of Macroeconomics: Between Phase II and Phase III ± Crucial inconsistency in Keynesian macroeconometric approach ± The estimated coefficients (the alpha’s) themselves may change if policy (monetary and/or fiscal) changes! ± In which case the macroeconometric approach cannot usefully give policy advice – unless one “knows”/makes assumptions about how the alpha’s themselves depend on policy… ± Discovered in the 1970’s amidst world-wide macroeconomic turbulence caused (seemingly…) by the two oil crises ± The usual Phillips relation “stopped working” even as policy-makers tried harder than ever to exploit it ± Led to breakdown of existing macroeconomic theory and opened the door for a complete re-thinking of the basic tenets of macroeconomics ± Keynesian macroeconometric models are not economic models ± Merely a statistical description of historical events ± Economics: the study of how incentives influence behavior of individuals/market participants ± A damning criticism of the entire macroeconomics profession… This “problem” was always present, but didn’t reveal itself until the 1970’s April 4, 2011 4 T HE F ALL OF M ACROECONOMICS The Evolution of Macroeconomics: Phase III ± “Macroeconomics” born as a field during and because of the Great Depression ±
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325_Lecture17_April4 - A BRIEF HISTORY OF...

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