In this final chapter we proceed to discuss the interaction of events and ideas in Dynamic Macroeconomics. This is likely to be an important determinant of its future evolution, but readers should be fully aware of the old Danish saying that “It is difficult to make predictions, especially about the future”
Macroeconomics started out in the 1930s based partly on ad hoc keynesian postulates, quite removed from the axioms of microeconomics. It has come full circle. Modern dynamic macroeconomics is fully grounded on microeconomics and general equilibrium theory. It only differs from intertemporal microeconomics in that it assumes markets for homogeneous commodities, labor, capital and financial assets. This is what allows us to formally define macroeconomic aggregates and analyze economies at the aggregate level.
Macroeconomics has experienced significant progress in the eighty or so years since the publication of the General Theory. There was progress in both growth theory and the theory of aggregate fluctuations. However, whereas progress in the theory of economic growth was more consensual, focussing on the differences between representative household and overlapping generations models, the role of human capital, externalities and endogenous technical progress, the evolution of the theory of aggregate fluctuations was characterized by sharp divisions and a lot of acrimony. After all, macroeconomics was founded on such a division, that between “Keynes and the Classics”. New divisions emerged in the 1950s and the 1960s between “keynesians and monetarists”, yet more divisions sprang up following the introduction of the “rational expectations hypothesis”, and the final set of divisions emerged in the 1980s, following the introduction of “new classical” dynamic stochastic general equilibrium (DSGE) models.
In the last twenty years or so, the sharp divisions of the past have been partly bridged, as macroeconomists of different persuasions communicate through the use models with more common elements than in the past. In any case the old divisions generated more heat than light. Yet, differences remain, regarding the nature of aggregate fluctuations, unemployment, and the product, labor and financial market distortions with macroeconomic consequences that must be addressed by monetary and fiscal policy.
Many of the remaining differences may be further resolved through the emergence of new empirical evidence, but a large part of the existing differences is due to the inconclusiveness of such evidence, as well as the different interpretations and approaches taken with regard to empirical evaluation, prediction and policy analysis.
We thus start by reviewing the current state of macroeconomics, then go on to discuss the role of empirical research in macroeconomics and finally examine the role of theoretically based empirical models in prediction and policy analysis. We end with some tentative conclusions about the likely future path of macroeconomics.