Macroeconomics At A Crossroads

This article describes the disconnect between academic macroeconomics and its application to the real world.  Academic macro is dominated by the development of models based upon microeconomics.  The assumption is that models of the economy, and the business cycle, can be developed using what micro economics tells us about how economic agents will behave in particular situations.  These models are not used in industry, and they are not used by financial institutions.  They are used by some central banks, and organizations like the IMF,  but they are not used by the Federal Reserve.  There are many forms of these models (DSGE) but they have not been useful in managing the business cycle.  The Fed still uses statistical models based upon correlation which were abandoned by academics in the 1980's who decided to build models based upon the "natural science" of microeconomics. 

It is unlikely that academics will abandon efforts to develop a "science of macroeconomics" based upon their understanding of human cognition.  They may give up on their efforts to model the entire economy and develop more specific models that might be useful in more specific applications.  The Fed will probably continue to use the older models that have been abandoned by academics to manage interest rates and the business cycle.  Given this situation, it should not be surprising that economists have different views about economic policy choices available to central banks and to government.  They don't share the same economic assumptions, and their views are also shaped by their political philosophies.  For example, one group of economists would like the Fed to raise its inflation target above 2%.  That will lower the real rate of interest (the nominal rate minus the inflation rate) and facilitate economic growth.  The other group believes that higher inflation and lower real interest rates are both dangerous and ineffective.