Which Way Forward for Macroeconomics and Policy Analysis?

There was a palpable sense of excitement among the economists who met in Philadelphia in 1969 at the conference organized by Edmund Phelps. Their research over the preceding years had coalesced into a new approach to macroeconomic analysis, one that based macrorelationships on explicit microfoundations. These foundations’ distinctive feature was to accord market participants’ expectations an autonomous role in economists’ models of aggregate outcomes. The conference contributions, published in what came to be known as “the Phelps microfoundations volume” (Phelps et al. 1970), provided radically new accounts of the comovements of macroeconomic aggregates—notably, inflation and unemployment. They also cast serious doubt on the validity of policy analysis based on then-popular Keynesian macroeconometric models. The Phelps volume is often credited with pioneering the currently dominant approach to macroeconomic analysis. Indeed, it is easy to see why today’s prevailing models of aggregate outcomes might seem to share much with their counterparts in the Phelps volume. Like their predecessors in the late 1960s, economists today often point to their models’ “microfoundations” as their essential feature. Moreover, in modeling decisionmaking, these microfoundations include a representation of market participants’ expectations. However, on closer inspection, the similarities between today’s models and those included in the Phelps volume are purely linguistic.