- The document discusses the history and evolution of macroeconomic thought from Keynes' work in the 1930s establishing modern macroeconomics to recent developments. - It describes the neoclassical synthesis of the 1950s which integrated Keynesian and classical ideas and the influential IS-LM model. - In the 1970s, the rational expectations critique challenged Keynesian models and assumptions, leading to new classical, new Keynesian, and new growth theory work. - By the late 1980s, these schools of thought had integrated rational expectations and nominal rigidities into models still used today like New Keynesian and DSGE models.

8. Lawrence Klein developed the first U.S. macroeconomic model in the early 1950s. The model was an extended IS relation, with 16 equations. 27-2 The Neoclassical Synthesis Progress on All Fronts Macroeconometric Models Klein

12. 27-2 The Neoclassical Synthesis The Phillips Curve Keynesians versus Monetarists The Phillips curve had become part of the Neoclassical synthesis, but Milton Friedman and Edmund Phelps argued that the apparent trade-off between unemployment and inflation would quickly vanish if policy makers actually tried to exploit it. By the mid 1970s, the consensus was that there was no long-run trade off between inflation and unemployment. Phelps

22. 27-3 The Rational Expectations Critique The Integration of Rational Expectations Wage and Price Setting Stanley Fischer and John Taylor showed that the adjustment of prices and wages in response to changes in unemployment can be slow even under rational expectations. They pointed to the staggering of both wage and price decisions, and explained how a slow return of output to the natural level can be consistent with rational expectations in the labor market. Fischer Taylor

24. 27-4 Recent Developments Since the late 1980s, three groups have dominated the research headlines: the new classicals, the new Keynesians, and the new growth theorists.

29. 27-4 Recent Developments New Growth Theory One example of some of the advances economists have made is on the work of Philippe Aghion and Peter Howitt. They have developed a theme first explored by Joseph Schumpeter in the 1930s, the notion that growth is a process of creative destruction , in which new products are constantly introduced, making old ones obsolete. Aghion Howitt

30. 27-4 Recent Developments New Growth Theory Andrei Shleifer (from Harvard University) has explored the role of different legal systems in affecting the organization of the economy, from financial markets to labor markets, and, through these channels, the effects of legal systems on growth. Daron Acemoglu (from MIT) has explored how to go from correlations between institutions and growth— democratic countries are on average richer—to causality from institutions to growth Shleifer Acemoglu

31. 27-4 Recent Developments New Growth Theory Woodford, Gali, and a number of co-authors have developed a model, known as the New-Keynesian model, that embodies utility and profit maximization, rational expectations, and nominal rigidities. This model has proven extremely useful and influential in the redesign of monetary policy. It has also led to the development of a class of larger models that build on its simple structure, but allow for a longer menu of imperfections and thus must be solved numerically. These models, which are now used in most central banks, are known as dynamic stochastic general equilibrium (DSGE) models. Woodford Gali