Edited by John B. Davis and D. Wade Hands
Chapter 16: Recent Developments in Macroeconomics: The DSGE Approach to Business Cycles in Perspective
Pedro Garcia Duarte1 16.1 INTRODUCTION In the late 1990s and early 2000s mainstream macroeconomists started seeing the fundamental disagreements they had about economic fluctuations vanish.2 Increasingly they understood that there was a common framework through which they could analyze such issues as the effects of real and nominal shocks on real activity, how monetary and fiscal policies should be designed in order to maximize welfare, and the importance or not that governments commit to a pre-established set of policy actions, among many others.3 This new consensus in macroeconomics became known as the new neoclassical synthesis, after Goodfriend and King (1997), and it emerged from the combination of the dynamic general equilibrium approach of the real business cycle (RBC) literature with the nominal rigidities and imperfect competition of the new Keynesian models. As a result of these rigidities, these general equilibrium models predict that monetary disturbances do have lasting effects on real variables (such as real output) in the short run, even if the influence of these shocks on aggregate nominal expenditure can be forecast in advance (Woodford, 2003, pp. 6–10; Galí, 2008, pp. 4–6). This result contrasts to those coming from both the earliest new classical models, in which monetary shocks can have transitory real effects only if they are unanticipated; and the RBC literature, in most of which there is no room for a monetary stabilization policy because real and nominal variables are modeled as evolving independently of each other, usually in a context of price flexibility.4...
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