Macroeconomics in Disarray

Macroeconomics in Disarray N. Gregory Mankiw (1) The basic questions of macroeconomics are: "What causes output and employment to fluctuate?" and "How should monetary and fiscal policymakers respond to these fluctuations?" As we sit here in the midst of the first recession in about a decade, these questions seem all the more pressing. Yet the sad truth is that we don't have answers to these questions that would command anything like a consensus among macroeconomists. In fact, one can fairly say that academic macroeconomics is in a state of disarray. I'd like to discuss this disarray among my colleagues and me, and the progress - and in some cases perhaps regress - that we've made in the past 20 years in answering these questions. It was easier being a student of macroeconomics 20 years ago. At that time, there was more agreement among macroeconomists about how the world works. At the textbook level, the accepted model of the economy was the IS-LM model - a theory that unified both Keynesian and monetarist views of the economy. Most economists used a Phillips curve of some sort to explain the adjustment of prices. There was disagreement about whether the trade-off between inflation and unemployment held only in the short run or also in the long run, and how long it took to reach the long run. But these disagreements seem relatively small from today's vantage point. At the more applied level, this consensus of 20 years ago was embodied in the large-scale macroeconometric models, such as the MPS model and the DRI model. The job of refining these models generated many dissertations. Private and public decisionmakers confidently used the models for forecasting and for evaluating alternative economic policies. Today, macroeconomists are much less sure of themselves. Graduate courses in macroeconomics, such as the one I teach at Harvard, hardly resemble those taught 20 years ago. The large-scale macroeconometric models are mentioned only occasionally at academic conferences; when they are mentioned, it is often with derision. A graduate student today is unlikely to devote his dissertation to improving the MPS model. In contrast to this radical change in the way academic macroeconomists have not substantially changed the way they analyze the economy. The textbook IS-LM model, augmented by the Phillips curve, continues to provide the best way to interpret discussions of economic policy in the press and among policymakers. From my own experiences at the Congressional Budget Office and the Council of Economic Advisers, I know that economists in government continue to use the large-scale macroeconometric models for forecasting and policy analysis. The theoretical developments of the past 20 years have had relatively little impact on applied macroeconomics. Why is there such a great disparity between academic and applied macroeconomics? The view of some academics is that practitioners have simply fallen behind the state of the art, that they continue to use obsolete models because they have not kept up with the quickly advancing field. Yet this self-serving view is suspect, for it violates a fundamental property of economic equilibrium: it assumes that a profit opportunity remains unexploited. If recent developments in macroeconomics were useful for applied work, they would have been adopted. The observation that recent developments have had little impact on applied macroeconomics creates at least the presumption that these developments are of little use to applied economists. One might be tempted to conclude that, because the macroeconomic research of the past 20 years has had little impact on applied economists, the research has no value. Yet this conclusion also is unwarranted. The past 20 years have been a fertile time for macroeconomics. Recent developments have just not been the sort that can be adopted quickly by applied economists. A Parable for Macroeconomics A tale from the history of science is helpful for understanding the current state of macroeconomics. …