A Brief History of Macro - Central European University
21
A Brief History of Macro IstvÆn Knya MNB and CEU September 2008 IstvÆn Knya A Brief History of Macro
Transcript of A Brief History of Macro - Central European University
A Brief History of Macro
István Kónya
MNB and CEU
September 2008
István Kónya A Brief History of Macro
The beginnings of macro
Macroeconomics did not exist as a separate �eld until the20th century
Before WWI, macro policy in most industrial countriesconcentrated only on the maintanance of the gold standardexchange rate system
The gold standard is an example of commodity money, whereone good (gold) is chosen to be the numeraireThis is di¤erent from the current systems, where the centralbank issues �at (paper) moneyExchange rates were �xed to gold, and hence to each otherPrices were just as likely to go up as down, there was nogeneral problem of in�ation
The rigidity and arbitrariness of the money supply led toswings in real economic activity
Limited franchise allowed policymakers to discount publicopinion
István Kónya A Brief History of Macro
War, in�ation and stabilization
Financing WWI was eventually done by monetizinggovernment debt (printing money) and suspendingconvertability
In continental Europe, this led to hyperin�ation during theaftermath of the war
Most industrial countries eventually re-entered the goldstandard as part of their stabilization e¤ortThe British pound, the central currency of the pre-WWI goldstandard, depreciated against the USD during the war (Britaindid not su¤er hyperin�ation)
For reasons of perceived credibility and perhaps some vanity,Britain chose to restore the pre-war parity
A good laboratory for the short-run non-neutrality of money
István Kónya A Brief History of Macro
WWI and its consequences
István Kónya A Brief History of Macro
The Great Depression
The Great Depression convinced economists that theself-correcting mechanisms, in particular the �exibility ofwages and the price level, need not work fast enough
Keynes developed a coherent system (a general equilibriummodel) to examine the e¤ect of rigid wages and prices on theinterdependent markets for labor, goods and money
He showed that in the absence of price adjustment, �scalpolicy can help an economy when output is below potentialMonetary policy can also help by increasing the moneysupply, altough Keynes was sceptical about its practical use
István Kónya A Brief History of Macro
The Great Depression and its aftermath
0.0
200.0
400.0
600.0
800.0
1000.0
1200.0
1400.0
1600.0
1800.0
2000.0
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945
Real GDP
István Kónya A Brief History of Macro
The Keynesian "Revolution"
Keynesian thinking dominated macro until the 1960�s, bothbecause of its appeal to activist policymakers and economists,and also because of its apparent success
Hicks developed the IS-LM model, a mathematical version ofKeynes�thinking which is still widely used in undergraduateeducation and (less fortunately) in policy discussions.
For 20-30 years, most macro was about measuring the gapbetween demand and potential output and stimulatingdemand su¢ ciently to reach potential.
István Kónya A Brief History of Macro
The "Golden Age"
0.0
500.0
1000.0
1500.0
2000.0
2500.0
3000.0
3500.0
4000.0
4500.0
5000.0
1948
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
Real GDP
István Kónya A Brief History of Macro
Neoclassical Synthesis
Growing prominence of optimization theory and marginalanalysis in microeconomics led to incorporation intomacroeconomic models.
Optimal models of saving, investment and demand forliquidity were used to describe a medium term equilibriumaround which the economy would �uctuate in the short-run.
During the 1950�s, macro conceptually split changes in outputinto two parts:
Long-term growth: models in which prices adjust perfectly toeconomic conditions.Business cycles: models in which they would not.Large empirical models were constructed and estimated, basedon advances in econometrics.
István Kónya A Brief History of Macro
Trend growth and business cycle
0.0
500.0
1000.0
1500.0
2000.0
2500.0
3000.0
3500.0
4000.0
4500.0
5000.0
1948
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
Real GDPLinear (Real GDP)
István Kónya A Brief History of Macro
Monetarism
In 1960�s, monetarists led by Milton Friedman began toemphasize the role of the money supply (as opposed to realdemand factors) as determinants of �uctuations in output andespecially in�ation.
In particular, Friedman pointed out the way that demandstimulus, once it becomes expected may lose its e¤ectiveness.
The Phillips curve debate
Based on statistical observations, many Keynesian economistsconcluded that there is an exploitable trade-o¤ betweenin�ation and unemploymentFriedman, Phelps and others argued that because in�ationexpectations adjust, the trade-o¤ cannot hold in the long run
István Kónya A Brief History of Macro
Stag�ation
2000.0
2500.0
3000.0
3500.0
4000.0
4500.0
5000.0
5500.0
6000.0
6500.0
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
Rea
l GD
P
0
2
4
6
8
10
12
14
16
18
Infla
tion
István Kónya A Brief History of Macro
The turbulent 70s
During the 1970�s, oil price shocks led to a period of rapidprice rises and low growth, called stag�ation.In many countries, in�ationary expectations led to wage-pricespirals and historically high in�ation rates.
This con�rmed the importance of expectations and theinstability of the Phillips curve
Developed economies begin 20 year slowdown in productivitygrowth rates.
In the early 1970�s, the US abandons the Bretton Woodssystem of �xed exchange rates, and exchange rates start to�oat.
After a few years of relative stability, exchange rates becomeone of the most volatile variables.Many new challenges emerge for international economics
István Kónya A Brief History of Macro
Rational expectations
Lucas develops economic theories which rigorously incorporatethe formation of expectations of future in economic models.
Calls for building models with explicit microfoundations,based on dynamic optimization by economic agents(households, �rms and possibly governments) in a stochasticenvironmentThe Lucas Critique states that empirical regularities that arenot derived from optimizing behavior are not invariant topolicy changes
Rational expectations models became widely accepted:They incorporate expectations in a way that is entirelyconsistent with rationality and optimizing behavior (i.e.microeconomics)They provided explanations for the rise of in�ationary spiralsand the seeming ine¤ectiveness of monetary policy.They provided the intellectual background for central bankindependence, pointing out time inconsistency problems
István Kónya A Brief History of Macro
Real Business Cycles
Early versions of microfounded rational expectations modelabandoned the Keynesian assumptions completely, andassumed that prices adjust �exibly and instantenously
The most in�uential work in this direction is the RealBusiness Cycle school
Showed that a large part of observed �uctuations may be dueto the e¢ cient response of economies to random disturbancesin production opportunities (productivity shocks)
The most important contribution of the RBC literature ismethodological: today most macroeconomic models are builton RBC foundations, and are subjected to rigorousquantitative evaluation
István Kónya A Brief History of Macro
The Volcker disin�ation
0.0
1000.0
2000.0
3000.0
4000.0
5000.0
6000.0
7000.0
1978 1979 1980 1981 1982 1983 1984 1985 1986
Rea
l GD
P
0
2
4
6
8
10
12
14
16
18
Infla
tion
István Kónya A Brief History of Macro
New Keynesians
RBC models cannot explain why monetary policy has a strongand lasting impact on economic activity
Using micro models of monopoly, a number of economistsdevelop rigorous models in which prices are sticky because ofadjustment costs.
Unlike RBC models, these models can explain why monetarypolicy has signi�cant e¤ects on output.
These models are typically static and cannot explain dynamicsor long-run at all.
István Kónya A Brief History of Macro
The Great Moderation
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Rea
l GD
P
0
1
2
3
4
5
6
Infla
tion
István Kónya A Brief History of Macro
The New Neoclassical Synthesis
Economists begin to incorporate New Keynesian models ofprice stickiness into uni�ed RBC framework.
These models explain which type of policies can o¤set e¤ectsof price-stickiness which might lead to underemploymentwithout leading to wage-price spirals.
Central banks have been relying extensively on insightsprovided by the insights of this literature.
The results of this e¤ort are the development and increasinguse of estimated DSGE (Dynamic Stochastic GeneralEquilibrium) models.
István Kónya A Brief History of Macro
What about growth?
Economists generally acknowledge that explaining sustainedgrowth is the "real thing"
There were two important waves of progress in growth theory
Late 50s to early 60s: the development of the neoclassicalmodel of "exogenous growth"Late 80s to early 90s: the development of "endogenousgrowth" models
No big dramatic events as in business cycle macro, but manyopen questions
Role of institutions, policy, openness, missing and incompletemarkets ...
István Kónya A Brief History of Macro
The end of the business cycle?
István Kónya A Brief History of Macro
