Recent Developments in the Theorv of Stabilization Policy

During the past decade the theoretical framework underlying macroeconomic stabilization analysis has undergone a number of significant developments. Theories designed to explain the crucial linkage between aggregate demand policy and real economic variables have been revised following the research on the “new microfoundations” of employment and inflation. Critical expectations effects of stabilization policy have been incorporated into the theoretical framework through the use of rational expectations. Optimal control techniques have become sophisticated enough to be used on large nonlinear econometric models, and more recently have been adapted for use in models with endogenous expectations. Supply considerations have been recognized as having important policy implications and, when necessary, have been incorporated into policy analyses. Theories underlying the choice between rules and discretionary policy have been altered and refined. These developments are likely to play an important role in the practical evaluation of economic policy in the years ahead. This paper reviews these developments in the theory of stabilization policy and outlines some of their implications for macroeconomic policy evaluation. The first section reviews the theories which have