The new macro models : washing our hands and watching for icebergs

The 1960s were an exciting time – at least for macroeconomic modelers. An impressive new kind of macroeconometric model was entering central banking, and cutting-edge central banks were beginning to analyze policy as a problem of optimal control. The December 1965 edition of Time, the popular U.S. news magazine, has Keynes on the cover, quotes the experts of the day extensively, and is almost giddy in tone regarding the successes of countercyclical policy. Indeed, one gets the impression that the future of the business cycle might be rather dull: ‘[U.S. businessmen] have begun to take for granted that the Government will intervene to head off recession or choke off inflation.’ By the revealed practice of central bankers, the new econometric models of the 1960s were a long-term success. The original models and their direct descendents remained workhorses of policy analysis at central banks for the next forty years or so. Were it not for the role the models played in the tragic economic events of the 1970s, this would be a very happy tale of scientific advance. We are once again in exciting times for macro modelers: a new breed of policy analysis model is entering central banking. Cutting-edge central banks are again beginning to analyze monetary policy as an optimal control problem within those models. For the first time since the mistakes of the 1970s, science is gaining ground in discussions of the art and science of monetary policymaking (e.g., Mishkin, 2007). At a central banking conference in 2007, I heard a senior central banker lament that the modern strategy of model-based flexible inflation targeting might render central banking rather dull.