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Thursday, December 01, 2005

Is There a New Consensus in Macroeconomics?

William Poole, president of the St. Louis Fed, in response to the question "Is there a new consensus in macroeconomics?":

Communicating the Fed's Policy Stance, William Poole, St. Louis Fed president: My short answer to the question posed ... is “yes.” The fundamental issues that created an enormous gulf between macroeconomists in the 1960s have been resolved. Of course, ... agreement on the most important fundamentals does not eliminate controversy about many important details.

In the U.S context, the most important single issue was that in 1965, say, economists conducted modeling and policy exercises in a control-theoretic framework. A changed view of expectations led to appreciation of the importance of the distinction between real and nominal interest rates and the view that in the long run the Phillips curve was vertical. Somewhat later but certainly by 1985, say, almost everyone believed that expectations of private agents about what policymakers would do had to be incorporated in models and policy analyses.

In 1965, expectations were almost uniformly modeled in a backward-looking way. As the rational expectations analysis took hold, the argument concerned the extent of rationality in formation of expectations. Were expectations rational in the sense of Muth (1961) or were they based on backward-looking and/or rules-of-thumb calculations? I would not claim that there is a consensus today on how to model expectations, but would claim that all serious macro economists believe that expectations cannot be adequately viewed as totally lacking in rational elements.(1) That is, markets do reflect efforts of private agents to look ahead, however imperfectly they may be able to do so.(2) And “looking ahead” certainly includes forming expectations as to what policymakers will do.

Poole continues the discussion of "looking ahead" to what policymakers will do as he talks about the Fed's communication strategy, a key concern of the Fed right now. I will post that part of his speech later today.

    Posted by on Thursday, December 1, 2005 at 09:40 AM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (4)

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