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1.2 The Role of Economic Theory and Controversy

An understanding by government policy makers of the factors which determine

the long-run growth of an economy and the short-run fluctuations that constitute

the business cycle is essential in order to design and implement economic

policies which have the potential vastly to improve economic welfare. The

primary aim of macroeconomic research is to develop as comprehensive an

understanding as possible of the way the economy functions and how it is

likely to react to specific policies and the wide variety of demand and supply

shocks which can cause instability. Macroeconomic theory, consisting of a set

of views about the way the economy operates, organized within a logical

framework (or theory), forms the basis upon which economic policy is designed

and implemented. Theories, by definition, are simplifications of reality.

This must be so given the complexity of the real world. The intellectual problem

for economists is how to capture, in the form of specific models, the

complicated interactive behaviour of millions of individuals engaged in economic

activity. Huntington (1996) has succinctly outlined the general case for

explicit modelling as an essential aid to thought:

Simplified paradigms or maps are indispensable for human thought. On the one

hand, we may explicitly formulate theories or models and consciously use them to

guide behaviour. Alternatively, we may deny the need for such guides and assume

that we will act only in terms of specific ‘objective’ facts, dealing with each case

‘on its own merits’. If we assume this, however, we delude ourselves. For in the

back of our minds are hidden assumptions, biases, and prejudices that determine

how we perceive reality, what facts we look at, and how we judge their importance

and merits.

Accordingly, explicit or implicit models are necessary to make sense of a very

complex world. By definition economic theories and specific models act as the

laboratories we otherwise lack in the social sciences. They help economists

decide what are the important factors that need to be analysed when they run

thought experiments about the causes and consequences of various economic

phenomena. A successful theory will enable economists to make better predictions

about the consequences of alternative courses of action thereby indicating

the policy regime most likely to achieve society’s chosen objectives.

The design of coherent economic policies aimed at achieving an acceptable

rate of economic growth and reduced aggregate instability depends then

on the availability of internally consistent theoretical models of the economy

which can explain satisfactorily the behaviour of the main macro variables

and are not rejected by the available empirical evidence. Such models provide

an organizing framework for reviewing the development and improvement

of institutions and policies capable of generating reasonable macroeconomic

stability and growth. However, throughout the twentieth century, economists

have often differed, sometimes substantially, over what is to be regarded as

the ‘correct’ model of the economy. As a result, prolonged disagreements and

controversies have frequently characterized the history of macroeconomic

thought (Woodford, 2000).

The knowledge that macroeconomists have today about the way that economies

function is the result of a prolonged research effort often involving

intense controversy and an ever-increasing data bank of experience. As

Blanchard (1997a) points out:

Macroeconomics is not an exact science but an applied one where ideas, theories,

and models are constantly evaluated against the facts, and often modified or

rejected … Macroeconomics is thus the result of a sustained process of construction,

of an interaction between ideas and events. What macroeconomists believe

today is the result of an evolutionary process in which they have eliminated those

ideas that failed and kept those that appear to explain reality well.

Taking a long-term perspective, our current understanding of macroeconomics,

at the beginning of the twenty-first century, is nothing more than yet

another chapter in the history of economic thought. However, it is important

to recognize from the outset that the evolution of economists’ thinking on

macroeconomics has been far from smooth. So much so that many economists

are not averse to making frequent use of terminology such as ‘revolution’

and ‘counter-revolution’ when discussing the history of macroeconomics.

The dramatic decline of the Keynesian conventional wisdom in the early

1970s resulted from both the empirical failings of ‘old Keynesianism’ and the

increasing success of critiques (‘counter-revolutions’) mounted by monetarist

and new classical economists (Johnson, 1971; Tobin, 1981, 1996; Blaug,

1997; Snowdon and Vane, 1996, 1997a, 1997b).

In our view, any adequate account of the current state of macroeconomics

needs to explore the rise and fall of the old ideas and the state of the new

within a comparative and historical context (see Britton, 2002). This book

examines, compares and evaluates the evolution of the major rival stories

comprising contemporary macroeconomic thought. We would maintain that

the coexistence of alternative explanations and views is a sign of strength

rather than weakness, since it permits mutual gains from intellectual trade

and thereby improved understanding. It was John Stuart Mill who recognized,

almost one hundred and fifty years ago, that all parties gain from the

comparative interplay of ideas. Alternative ideas not only help prevent

complacency, where ‘teachers and learners go to sleep at their post as soon

as there is no enemy in the field’ (Mill, 1982, p. 105), but they also provide

a vehicle for improved understanding whereby the effort to comprehend

alternative views forces economists to re-evaluate their own views. Controversy

and dialogue have been, and will continue to be, a major engine for

the accumulation of new knowledge and progress in macroeconomics. We

would therefore endorse Mill’s plea for continued dialogue (in this case

within macroeconomics) between the alternative frameworks and suggest

that all economists have something to learn from each other. The macroeconomic

problems that economists address and endeavour to solve are

often shared.

That there is a wide variety of schools of thought in economics in general,

and macroeconomics in particular, should not surprise us given the intrinsic

difficulty and importance of the issues under investigation. While there are

‘strong incentives in academia to differentiate products’ (Blanchard and Fischer,

1989), there is no doubt that much of the controversy in macroeconomics

runs deep. Of course, it is true that economists disagree on many issues, but

they seem to do so more frequently, vociferously, and at greater length, in

macroeconomics. In his discussion of why there is much controversy in

macroeconomics Mayer (1994) identifies seven sources, namely, limited knowledge

about how the economy works, the ever-widening range of issues that

economists investigate, the need to take into account wider influences, such

as political factors, and differences in the ‘metaphysical cores, value judgements,

social empathies and methodologies’ of various economists. Knut

Wicksell’s (1958, pp. 51–2) contention that within economics ‘the state of

war seems to persist and remain permanent’ seems most appropriate for

contemporary macroeconomics. To a large extent this reflects the importance

of the issues which macroeconomists deal with, but it also supports the

findings of previous surveys of economists which revealed a tendency for

consensus to be stronger on microeconomic compared to macroeconomic

propositions (see, for example, Alston et al., 1992).

It is certainly true that in specific periods during the twentieth century the

contemporary state of macroeconomic theory had the appearance of a battlefield,

with regiments of economists grouped under different banners. However,

it is our view that economists should always resist the temptation to embrace,

in an unquestioning way, a one-sided or restrictive consensus ‘because the

right answers are unlikely to come from any pure economic dogma’ (Deane,

1983). In addition, the very nature of scientific research dictates that disagreements

and debate are most vocal at the frontier, as they should be, and, as

Robert E. Lucas Jr argues (see interview at the end of Chapter 5), the responsibility

of professional economists is ‘to create new knowledge by pushing

research into new, and hence necessarily controversial, territory. Consensus

can be reached on specific issues, but consensus for a research area as a

whole is equivalent to stagnation, irrelevance and death.’ Furthermore, as

Milton Friedman observes (see interview at the end of Chapter 4), ‘science in

general advances primarily by unsuccessful experiments that clear the ground’.

Macroeconomics has witnessed considerable progress since its birth in the

1930s. More specifically, any Rip Van Winkle economist who had fallen

asleep in 1965, when the ‘old Keynesian’ paradigm was at its peak, would

surely be impressed on waking up at the beginning of the twenty-first century

and surveying the enormous changes that have taken place in the macroeconomics