Thirty-Five Years of Model Building for Monetary Policy Evaluation: Breakthroughs, Dark Ages, and a Renaissance

ONE OF THE most important advances in monetary policy analysis in the past three decades has been the development and use of economy-wide econometric models that combine forward-looking rational expectations and sticky prices or wages. Such models are so commonplace now that the idea hardly deserves comment and indeed the structural models presented at this conference are no exception. But no such models existed at the time that the Econometrics of Price Determination Conference was held 35 years ago. The paper by Robert Lucas (1972a) at that conference presented a rational expectations model, but it had perfectly flexible prices—neither time-dependent price setting, as in the future staggered contract models, nor state-dependent price setting, as in the future menu cost models. Other papers at the 1970 conference—still reflecting what was common in econometric macro models at the time—focused on backward-looking models of the wage–price dynamics featuring inflexible markups from wages to prices and adaptive expectations. Expectations of inflation, important for price determination following the Friedman–Phelps hypothesis, were therefore very slow to change unlike in the rational expectations models.