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Unformatted text preview: THE TRANSFORMATION OF MACROECONOMIC POLICY AND RESEARCH Prize Lecture, December 8, 2004 by Edward C. Prescott* Arizona State University, Tempe, and Federal Reserve Bank of Minneapolis, Minnesota, USA. 1. INTRODUCTION What I am going to describe for you is a revolution in macroeconomics, a transformation in methodology that has reshaped how we conduct our science. Prior to the transformation, macroeconomics was largely separate from the rest of economics. Indeed, some considered the study of macroeconomics fundamentally different and thought there was no hope of integrating macroeconomics with the rest of economics, that is, with neoclassical economics. Others held the view that neoclassical foundations for the empirically deter- mined macro relations would in time be developed. Neither view proved correct. Finn Kydland and I have been lucky to be a part of this revolution, and my address will focus heavily on our role in advancing this transformation. Now, all stories about transformation have three essential parts: the time prior to the key change, the transformative era, and the new period that has been impacted by the change. And that is the story I am going to tell: how macro- economic policy and research changed as the result of the transformation of macroeconomics from constructing a system of equations of the national accounts to an investigation of dynamic stochastic economies. Macroeconomics has progressed beyond the stage of searching for a theory to the stage of deriving the implications of theory. In this way, macroeconomics has become like the natural sciences. Unlike the natural sciences, though, macroeconomics involves people making decisions based upon what they think will happen, and what will happen depends upon what decisions they make. This means that the concept of equilibrium must be dynamic, and as we shall see this dynamism is at the core of modern macroeconomics. 370 *Thanks to Dave Fettig, Tim Kehoe, Robert Lucas, Ellen McGrattan, Lee Ohanian, Richard Rogerson, and Art Rolnick for their helpful comments and the National Science Foundation for financial support (grant #0422539). Before proceeding, I want to emphasize that the methodology that transform- ed macroeconomics is applicable to the study of virtually all fields of econom- ics. In fact, the meaning of the word macroeconomics has changed to refer to the tools being used rather than just to the study of business cycle fluctuations. As a result of the transformation, these are exciting times in macroeconom- ics. The methodology that Finn and I developed for the study of business cy- cle fluctuations is being used to advance learning not only in the area of business cycles but also in virtually all areas of economics. By using this methodology, researchers are able to apply theory and measurement to answer questions, define puzzles, and determine where better measurement is needed before specific questions can be answered....
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