page_title: History of macroeconomic thought
section_title: New synthesis
hierarchical_section_title: History of macroeconomic thought / New synthesis
caption_attribution_description: English: Impulse response functions for output, inflation, consumption, and real interest rates in response to a one standard deviation shock to monetary policy over 20 quarters. The model used was presented in Christiano, Eichenbaum, and Evans (2005) "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy." Based on Roberto Croce's implementation of the model in Dynare. http://web.econ.ohio-state.edu/~croce/codes.html.
context_page_description: Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
  The generation of economists that followed Keynes synthesized his theory with neoclassical microeconomics to form the neoclassical synthesis. Although Keynesian theory originally omitted an explanation of price levels and inflation, later Keynesians adopted the Phillips curve to model price-level changes. Some Keynesians opposed the synthesis method of combining Keynes's theory with an equilibrium system and advocated disequilibrium models instead.
context_section_description: A "new synthesis" or "new neoclassical synthesis" emerged in the 1990s drawing ideas from both the new Keynesian and new classical schools. From the new classical school, it adapted RBC hypotheses, including rational expectations, and methods; from the new Keynesian school, it took nominal rigidities (price stickiness) and other market imperfections. New synthesis theory developed RBC models called dynamic stochastic general equilibrium (DSGE) models. DSGE models formulate hypotheses about the behaviors and preferences of firms and households; numerical solutions of the resulting DSGE models are computed. These models also included a "stochastic" element created by shocks to the economy. In the original RBC models these shocks were limited to technological change, but more recent models have incorporated other real changes. DSGE models have a theoretical advantage, avoiding the Lucas critique. The new synthesis was adopted by academic economists and soon by policy makers, such as central bankers.
  Econometric analysis of DSGE models suggested that real factors sometimes affect the economy. A paper by Frank Smets and Rafael Woulters (2007) stated that monetary policy explained only a small part of the fluctuations in economic output. In new synthesis models, shocks can affect both demand and supply. The new synthesis implies that monetary policy can have a stabilizing effect on the economy, contrary to new classical theory.
  Under the synthesis, debates have become less ideological and more methodological. Business cycle modelers can be broken into two camps: those in favor of calibration and those in favor of estimation. When models are calibrated, the modeler selects parameter values based on other studies or casual empirical observation. Instead of using statistical diagnostics to evaluate models, the model's operating characteristics determine the quality of the model. Kydland and Prescott (1982) offered no formal evaluation of their model, but noted how variables like hours worked did not match real data well while the variances of other elements of the model did. When estimation methods are used, models are evaluated based on standard statistical goodness of fit criteria. Calibration is generally associated with real business cycle modelers of the new classical school, but methodological differences cut across ideology. While Lucas, Prescott, and Kydland are calibration advocates, another prominent new classical, Sargent, favors estimation.
caption: Based on the DSGE model in Christiano, Eichenbaum, and Evans (2005),[ad] impulse response functions show the effects of a one standard deviation monetary policy shock on other economic variables over 20 quarters.
exif: {}