Otherwise, the macro models will have little or no value for the policymakers who must make hard decisions based on the policy implications of the models. Models today have in fact evolved to be quite different from those in the 1970s. Then, macro models placed much emphasis on demand-driven outcomes for the economy. That was because governments believed in the power of discretionary monetary and fiscal policies to promote high growth and low inflation. However, the repeated failure of such macro models to identify critical turning points in the 1970s and 1980s caused many economists to question the old assumptions behind the models. It then became clear that supply-side factors and the role of expectations also needed to be worked in. Thus, today many macro models build in these factors. One example is how most models now work in the impact of the economy’s potential output on inflation outcomes. In the US, modellers are faced with growing evidence of an emergent “New Economy”. The hypothesis is that high rates of growth can be sustained without triggering off inflationary pressures, even at the point of full employment. I understand that staff from the Federal Reserve constantly update their estimates of key model parameters, such as the NAIRU2 as well as trend productivity to reflect the features of this New Economy. These updated estimates have been used to help shape the Fed’s forecasts of growth and inflation, thereby ensuring that the policymaking process is an informed one.
The second quality I have in mind refers specifically to the model’s role in forecasting and policy analysis. A model must have a good track record, in order to serve as a reliable guide to the policymaker. I am not asking for spot-on point forecasts or estimates but, at a minimum, a macro model must be able to provide policymakers with a good feel for the directional effects of various policy options. Thirdly, the workings of the model must be transparent. Ideally, the structure of the model should correspond to a flowchart of the linkages within the economy. Fed Governor Laurence Meyer has said in a recent speech3 that model-based forecasting needs to “start with a paradigm and end with a story”. 2 3  Non-Accelerating Inflation Rate of Unemployment. To the Stern Graduate School of Business, New York University: “Start with a Paradigm, End with a Story: The Value of Model-Based Forecasting and Policy Analysis”. BIS Review 9/2000  2  Ultimately, when policymakers want to introduce policy changes, they want to know through what channels the effect of this policy will flow and how agents will react to this policy. In other words, policymakers want to know the story going on behind each policy reaction and not just be buried under masses of model output. Fourth, macro modelling should adopt a pluralistic approach. Policymakers are like consumers while macro modellers are the producers. As the well-known econometrician Clive Granger4 said, “it is worth remembering that consumers usually prefer having a choice.