Although the tools for doing macroeconomics and, more specifically, business cycle analysis have undergone radical changes during the last twenty five years or so, it still feels right to argue that much of the ongoing macroeconomic research on fluctuations can be regarded as inquiries into the aggregate implications of various imperfections. In this context, Olivier Blanchard, in his review of the current state of macroeconomics, sets out a series of questions that greatly shape the way we still do macro. Apart from nominal rigidities, like slowly adjusting nominal prices, what are the frictions that matter most for macro? How do they affect the dynamic effects of different shocks? How do they introduce at least the possibility of additional shocks? What do we know about these dynamic effects and how important are these shocks?
Of course, the original real business cycle models were free of these frictions and focused on the business cycle implications of aggregate technology shocks in models with optimizing agents and fully flexible prices. However, there has been a convergence of views among business cycle researchers that technological shocks may not be the main drivers of business cycle fluctuations and that aggregate demand factors need to be given a greater role in our models to be able to account for the observed fluctuations of the key macroeconomic quantities at the business cycle frequency.
Although progress in modelling macroeconomic fluctuations has been impressive, our basic models for doing monetary business cycle analysis are not complete and a lot of work remains to be done in order for these models to pass the tests of providing a fully satisfactory basis for eg policy advice. New empirical puzzles and challenges keep emerging, and often ad hoc assumptions and empirically non-validated elements need to be incorporated into these models in order for them to match required macroeconomic regularities. Moreover, it is only quite recently that a serious effort has been made to explore the asset pricing implications of our standard monetary business cycle models and to subject the models' empirical implications to stringent econometric tests. These acid tests should be regarded as critical both for the successful development of the underlying models and for understanding their macroeconomic implications in full.
Perhaps an even more striking characteristic of our basic model for doing monetary policy analysis, the new-Keynesian (NK) model, is that there is no unemployment. Movements in employment take place along the labour supply schedule, either at the intensive margin through variations in hours worked or at the extensive margin through households' decisions on labour market participation. One may argue that this is a misleading description of actual labour market outcomes in most countries. The natural question is then how to think about and introduce unemployment into the NK model.
Fortunately, a lot of progress has taken place on this front, too. More specifically, we can build rigorous equilibrium models of labour market behaviour based on labour market search and incorporate these models into our basic monetary business cycle models to provide the required microeconomic foundations for unemployment in these models. In labour markets subject to search frictions, unemployment results from the fact that these markets are decentralized, with, at any given moment in time, some workers searching for a job and some firms with vacancies looking for workers. The implication is that there is always some unemployment and vacancies. From the point of view of macro fluctuations, the important question is what the implications of labour market search frictions are for the dynamics of key macro variables and, in particular, whether the dynamics are different from those generated by the standard models based on the representative agent approach to labour markets. Differences do emerge, but more research is needed to make us more confident that they are both qualitatively and quantitatively important and to make the research effort worth taking. |