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ly used in academia in teaching and research and are also widely used by international organizations national governments and larger corporations as well as by economic consultants and think tanks types edit simple theoretical models edit simple textbook descriptions of the macroeconomy involving a small number of equations or diagrams are often called models examples include the is lm model and mundell fleming model of keynesian macroeconomics and the solow model of neoclassical growth theory these models share several features they are based on a few equations involving a few variables which can often be explained with simple diagrams 2 many of these models are static but some are dynamic describing the economy over many time periods the variables that appear in these models often represent macroeconomic aggregates such as gdp or total employment rather than individual choice variables and while the equations relating these variables are intended to describe economic decisions they are not usually derived directly by aggregating models of individual choices they are simple enough to be used as illustrations of theoretical points in introductory explanations of macroeconomic ideas but therefore quantitative application to forecasting testing or policy evaluation is usually impossible without substantially augmenting the structure of the model empirical forecasting models edit main article large scale macroeconometric model in the 1940s and 1950s as governments began accumulating national income and product accounting data economists set out to construct quantitative models to describe the dynamics observed in the data 3 these models estimated the relations between different macroeconomic variables using mostly linear time series analysis like the simpler theoretical models these empirical models described relations between aggregate quantities but many addressed a much finer level of detail for example studying the relations between output employment investment and other variables in many different industries thus these models grew to include hundreds or thousands of equations describing the evolution of hundreds or thousands of prices and quantities over time making computers essential for their solution while the choice of which variables to include in each equation was partly guided by economic theory for example including past income as a determinant of consumption as suggested by the theory of adaptive expectations variable inclusion was mostly determined on purely empirical grounds 4 dutch economist jan tinbergen developed the first comprehensive national model which he built for the netherlands in 1936 he later applied the same modeling structure to the economies of the united states and the united kingdom 3 the first global macroeconomic model wharton econometric forecasting associates link project was initiated by lawrence klein the model was cited in 1980 when klein like tinbergen before him won the nobel prize large scale empirical models of this type including the wharton model are still in use today especially for forecasting purposes 5 6 7 the lucas critique of empirical forecasting models edit main article lucas critique econometric studies in the first part of the 20th century showed a negative correlation between inflation and unemployment called the phillips curve 8 empirical macroeconomic forecasting models being based on roughly the same data had similar implications they suggested that unemployment could be permanently lowered by permanently increasing inflation however in 1968 milton friedman 9 and edmund phelps 10 argued that this apparent tradeoff was illusory they claimed that the historical relation between inflation and unemployment was due to the fact that past inflationary episodes had been largely unexpected they argued that if monetary authorities permanently raised the inflation rate workers and firms would eventually come to understand this at which point the economy would return to its previous higher level of unemployment but now with higher inflation too the stagflation of the 1970s appeared to bear out their prediction 11 in 1976 robert lucas jr published an influential paper arguing that the failure of the phillips curve in the 1970s was just one example of a general problem with empirical forecasting models 12 13 he pointed out that such models are derived from observed relationships between various macroeconomic quantities over time and that these relations differ depending on what macroeconomic policy regime is in place in the context of the phillips curve this means that the relation between inflation and unemployment observed in an economy where inflation has usually been low in the past would differ from the relation observed in an economy where inflation has been high 14 furthermore this means one cannot predict the effects of a new policy regime using an empirical forecasting model based on data from previous periods when that policy regime was not in place lucas argued that economists would remain unable to predict the effects of new policies unless they built models based on economic fundamentals like preferences technology and budget constraints that should be unaffected by policy changes dynamic stochastic general equilibrium models edit main article dynamic stochastic general equilibrium partly as a response to the lucas critique economists of the 1980s and 1990s began to construct microfounded 15 macroeconomic models based on rational choice which have come to be called dynamic stochastic general equilibrium dsge models these models begin by specifying the set of agents active in the economy such as households firms and governments in one or more countries as well as the preferences technology and budget constraint of each one each agent is assumed to make an optimal choice taking into account prices and the strategies of other agents both in the current period and in the future summing up the decisions of the different types of agents it is possible to find the prices that equate supply with demand in every market thus these models embody a type of equilibrium self consistency agents choose optimally given the prices while prices must be consistent with agents supplies and demands dsge models often assume that all agents of a given type are identical i e there is a representative household and a representative firm and can perform perfect calculations that forecast the future correctly on average which is called rational expectations however these are only simplifying assumptions and are not essential for the dsge methodology many dsge studies aim for greater realism by considering heterogeneous agents 16 or various types of adaptive expectations 17 compared with empirical forecasting models dsge models typically have fewer variables and equations mainly because dsge models are harder to solve even with the help of computers 18 simple theoretical dsge models involving only a few variables have been used to analyze the forces that drive business cycles this empirical work has given rise to two main competing frameworks called the real business cycle model 19 20 21 and the new keynesian dsge model 22 23 more elaborate dsge models are used to predict the effects of changes in economic policy and evaluate their impact on social welfare however economic forecasting is still largely based on more traditional empirical models which are still widely believed to achieve greater accuracy in predicting the impact of economic disturbances over time dsge versus cge models edit main article computable general equilibrium a methodology that pre dates dsge modeling is computable general equilibrium cge modeling like dsge models cge models are often microfounded on assumptions about preferences technology and budget constraints however cge models focus mostly on long run relationships making them most suited to studying the long run impact of permanent policies like the tax system or the openness of the economy to international trade 24 25 dsge models instead emphasize the dynamics of the economy over time often at a quarterly frequency making them suited for studying business cycles and the cyclical effects of monetary and fiscal policy agent based computational macroeconomic models edit main article agent based computational economics another modeling methodology is agent based computational economics ace which is a variety of agent based modeling 26 like the dsge methodology ace seeks to break down aggregate macroeconomic relationships into microeconomic decisions of individual agents ace models also begin by defining the set of agents that make up the economy and specify the types of interactions individual agents can have with each other or with the market as a whole instead of defining the preferences of those agents ace models often jump directly to specifying their strategies or sometimes preferences are specified together with an initial strategy and a learning rule whereby the strategy is adjusted according to its past success 27 given these strategies the interaction of large numbers of individual agents who may be very heterogeneous can be simulated on a computer and then the aggregate macroeconomic relationships that arise from those individual actions can be studied strengths and weaknesses of dsge and ace models edit dsge and ace models have different advantages and disadvantages due to their different underlying structures dsge models may exaggerate individual rationality and foresight and understate the importance of heterogeneity since the rational expectations representative agent case remains the simplest and thus the most common type of dsge model to solve also unlike ace models it may be difficult to study local interactions between individual agents in dsge models which instead focus mostly on the way agents interact through aggregate prices on the other hand ace models may exaggerate errors in individual decision making since the strategies assumed in ace models may be very far from optimal choices unless the modeler is very careful a related issue is that ace models which start from strategies instead of preferences may remain vulnerable to the lucas critique a changed policy regime should generally give rise to changed strategies see also edit economic model mathematical model macroeconomics economics econometrics computational economics lucas critique dynamic stochastic general equilibrium agent based computational economics history of macroeconomic thought time series moniac an analogue computer which used fluidic logic to model the workings of an economy references edit blanchard olivier january 12 2017 the need for different classes of macroeconomic models peterson institute for international economics retrieved february 22 2022 blanchard olivier 2000 macroeconomics 2nd ed chap 3 3 p 47 prentice hall isbn 0 13 013306 x 1 2 klein lawrence 2004 the contribution of jan tinbergen to economic science de economist 152 2 155 157 doi 10 1023 b ecot 0000023251 14849 4f s2cid 154689887 koopmans tjalling c 1947 measurement without theory review of economics and statistics 29 3 161 172 doi 10 2307 1928627 jstor 1928627 klein lawrence r ed 1991 comparative performance of us econometric models oxford university press isbn 0 19 505772 4 eckstein otto 1983 the dri model of the us economy mcgraw hill isbn 0 07 018972 2 bodkin ronald klein lawrence marwah kanta 1991 a history of macroeconometric model building edward elgar phillips a w 1958 the relationship between unemployment and the rate of change of money wages in the united kingdom 1861 1957 economica 25 100 283 299 doi 10 2307 2550759 jstor 2550759 friedman milton 1968 the role of monetary policy american economic review 58 1 american economic association 1 17 jstor 1831652 phelps edmund s 1968 money wage dynamics and labor market equilibrium journal of political economy 76 4 678 711 doi 10 1086 259438 s2cid 154427979 blanchard olivier 2000 op cit ch 28 p 540 lucas robert e jr 1976 econometric policy evaluation a critique pdf carnegie rochester conference series on public policy 1 19 46 doi 10 1016 s0167 2231 76 80003 6 hoover kevin d 1988 econometrics and the analysis of policy the new classical macroeconomics oxford basil blackwell pp 167 209 isbn 0 631 14605 9 blanchard olivier 2000 op cit ch 28 p 542 edmund s phelps ed 1970 microeconomic foundations of employment and inflation theory new york norton and co isbn 0 393 09326 3 krusell per smith anthony a jr 1998 income and wealth heterogeneity in the macroeconomy journal of political economy 106 5 243 277 doi 10 1086 250034 s2cid 17606592 george w evans and seppo honkapohja 2001 learning and expectations in macroeconomics princeton university press isbn 0 691 04921 1 dejong d n with c dave 2007 structural macroeconometrics princeton university press isbn 0 691 12648 8 kydland finn e prescott edward c 1982 time to build and aggregate fluctuations econometrica 50 6 1345 70 doi 10 2307 1913386 jstor 1913386 thomas f cooley 1995 frontiers of business cycle research princeton university press andrew abel and ben bernanke 1995 macroeconomics 2nd ed ch 11 1 pp 355 362 addison wesley isbn 0 201 54392 3 rotemberg julio j woodford michael 1997 an optimization based econometric framework for the evaluation of monetary policy pdf nber macroeconomics annual 12 297 346 doi 10 1086 654340 jstor 3585236 s2cid 154438345 woodford michael 2003 interest and prices foundations of a theory of monetary policy princeton university press isbn 0 691 01049 8 shoven john b whalley john 1972 a general equilibrium calculation of the effects of differential taxation of income from capital in the us pdf journal of public economics 1 3 4 281 321 doi 10 1016 0047 2727 72 90009 6 archived from the original pdf on 2022 02 26 retrieved 2019 07 12 kehoe patrick j kehoe timothy j 1994 a primer on static applied general equilibrium models pdf federal reserve bank of minneapolis quarterly review 18 1 2 16 tesfatsion leigh 2003 agent based computational economics pdf iowa state university economics working paper 1 brock william hommes cars 1997 a rational route to randomness econometrica 65 5 1059 1095 doi 10 2307 2171879 jstor 2171879 external links edit macroeconomic modeling the cowles commission approach by ray fair fairmodel us models to download jamel an on line interactive agent based macroeconomic model v t e macroeconomics basic concepts output and measurement growth business cycle financial crisis recession depression national accounts sna gdp gni nni output gap unemployment money and prices exchange rate inflation cost push deflation demand pull disinflation price level shrinkflation stagflation interest rate liquidity trap money creation demand liquidity preference endogenous supply dynamics and theory aggregate demand effective demand aggregate supply balance of payments expectations adaptive rational government debt investment saving microfoundations nominal rigidity shocks demand s...