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Modern Macroeconomics in Practice: How Theory Is Shaping Policy
V. V. Chari and Patrick J. Kehoe
Over the last three decades, macroeconomic theory and the practice of macroeconomics by economists have changed significantly—for the better. Macroeconomics is now firmly grounded in the principles of economic theory. We focus on the role of economic theory in shaping policy. Over the last several decades, the United States and other countries have undertaken a variety of policy changes that are precisely what macroeconomic theory of the last 30 years suggests. The evidence that theoretical advances have had a significant effect on the practice of policy is often hard to see for policymakers and advisers involved in the hurly-burly of day-to-day policymaking, but easy to see if one steps back and takes a longer-term perspective. Examples of the effects of theory on the practice of policy include increased central bank independence; adoption of inflation targeting and other rules to guide monetary policy; increased reliance on consumption and labor taxes instead of capital income taxes; and increased awareness of the costs of policies that distort labor markets.
The Macroeconomist as Scientist and Engineer
N. Gregory Mankiw
The subfield of macroeconomics was born, not as a science, but more as a type of engineering. The problem that gave birth to our field was the Great Depression. God put macroeconomists on earth not to propose and test elegant theories but to solve practical problems. This essay offers a brief history of macroeconomics, together with an evaluation of what we have learned. My premise is that the field has evolved through the efforts of two types of macroeconomists—those who understand the field as a type of engineering and those who would like it to be more of a science. While the early macroeconomists were engineers trying to solve practical problems, the macroeconomists of the past several decades have been more interested in developing analytic tools and establishing theoretical principles. These tools and principles, however, have been slow to find their way into applications. As the field of macroeconomics has evolved, one recurrent theme has been the interaction -- sometimes productive and sometimes not -- between the scientists and the engineers. John Maynard Keynes (1931) famously opined, "If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid." As we look ahead, "humble" and "competent" remain ideals toward which macroeconomists can aspire.
The Real Effects of European Monetary Union
Philip R. Lane
We explore the impact of European monetary union on the economies of the member countries. Inflation differentials across the euro area have been persistent, such that cumulative real exchange rate movements across the euro area have been quite substantial. The adoption of the euro has indeed contributed to greater economic integration; however, economic linkages with the rest of the world have also been growing strongly, such that the relative importance of trade within the European monetary union has not dramatically increased. In terms of future risks, a severe economic downturn or financial crisis in a member country will be the proving ground for the future political viability of the euro.
The European Central Bank, the Euro, and Global Financial Markets
Kathryn M. E. Dominguez
The economic case for European monetary union was shaky at best when it was first discussed 35 years ago. Europe's leaders felt that monetary union was the capstone to their efforts to create an integrated Europe, and much to the rest of the world's surprise, they succeeded. The introduction of the euro and the establishment of the European Central Bank (ECB) as the monetary authority of Europe went much more smoothly than many predicted. But nagging doubts about the wisdom of integration persist. The slim margins by which the Maastricht Treaty passed and the wide margin on which the European Constitution failed are reminders that Europeans are still wary of giving up their national sovereignty. This wariness also influences the ability of the ECB to efficiently take over monetary policy and limits the ability of the euro to become a true rival of the dollar in global financial markets.
Interview with Robert A. Mundell
Howard R. Vane and Chris Mulhearn
Robert A. Mundell has been Professor of Economics at Columbia University in New York City, New York, since 1974 and University Professor since 2001. In 1999, he was awarded the Nobel Memorial Prize in Economic Science "for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas." We interviewed Professor Mundell at his hotel in Boston, Massachusetts, on January 7, 2006, while attending the annual meeting of the Allied Social Science Associations.
Avoiding Invalid Instruments and Coping with Weak Instruments
Michael P. Murray
Archimedes said, "Give me the place to stand, and a lever long enough, and I will move the Earth." Economists have their own powerful lever: the instrumental variable estimator. The instrumental variable estimator can avoid the bias that ordinary least squares suffers when an explanatory variable in a regression is correlated with the regression's disturbance term. But, like Archimedes? lever, instrumental variable estimation requires both a valid instrument on which to stand and an instrument that isn't too short (or "too weak"). This paper briefly reviews instrumental variable estimation, discusses classic strategies for avoiding invalid instruments (instruments themselves correlated with the regression's disturbances), and describes recently developed strategies for coping with weak instruments (instruments only weakly correlated with the offending explanator).
The Homecoming of American College Women: The Reversal of the College Gender Gap
Claudia Goldin, Lawrence F. Katz and Ilyana Kuziemko
Women are currently the majority of U.S. college students and of those receiving a bachelor's degree, but were 39 percent of undergraduates in 1960. We use three longitudinal data sets of high school graduates in 1957, 1972, and 1992 to understand the narrowing of the gender gap in college and its reversal. From 1972 to 1992 high school girls narrowed the gap with boys in math and science course taking and in achievement test scores. These variables, which we term the proximate determinants, can account for 30 to 60 percent of the relative increase in women's college completion rate. Behind these changes were several others: the future work expectations of young women increased greatly between 1968 and 1979 and the age at first marriage for college graduate women rose by 2.5 years in the 1970s, allowing them to be more serious students. The reversal of the college gender gap, rather than just its elimination, was due in part to the persistence of behavioral and developmental differences between males and females.
The London Congestion Charge
Jonathan Leape
By the 1990s, the average speed of trips across London was below that at the beginning of the twentieth century—before the car was introduced—and by the end of that decade, public concern over levels of traffic congestion was high. In early 2003, London imposed a congestion charge—a daily charge for driving or parking a vehicle on public roads within central London between the hours of 7:00 a.m. and 6:30 p.m. on workdays. Traffic congestion has declined substantially, and the program is largely popular. This article describes the origins of the London congestion charge, how it overcame practical and theoretical difficulties, and what effects it has had. The introduction of the London congestion charge is, in important respects, a triumph of economics. It represents a high-profile public and political recognition of congestion as a distorting externality and of road pricing as an appropriate policy response.
How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes
Burton A. Abrams
Evidence from the Nixon tapes, now available to researchers, shows that President Richard Nixon pressured the chairman of the Federal Reserve, Arthur Burns, to engage in expansionary monetary policies in the run-up to the 1972 election. This paper quotes the relevant conversations from the Nixon tapes. Questions remain as to whether Burns followed an expansionary policy in an already-inflationary environment out of conviction or because of political pressure.
What Has Mattered to Economics Since 1970
E. Han Kim, Adair Morse and Luigi Zingales
Citations are one way that past research echoes through time. In this paper, we compile a list of articles published in major refereed economics journals in the last 35 years that have received more than 500 citations as of June 2006. We then use this list to examine various trends: what fields of economics are most in vogue; what types of articles generate the most interest; and which institutions host the production of these articles and train their authors.
Markets: The U.S. Lodging Industry
Arturs Kalnins
The U.S. lodging industry appears highly competitive. Ownership concentration appears to be low. Fixed costs are high relative to variable costs and unused rooms cannot be stored for future sale, so price-cutting should be attractive. However, this paper argues that, unexpectedly, oligopolistic market structures in many local lodging markets, combined with behavioral norms of cooperation, sustain profits in what might otherwise be an industry of cutthroat competition. I describe the patterns of competition and cooperation in the U.S. lodging industry, summarizing theoretical arguments, empirical research, descriptive statistics from industry and government sources, and anecdotal evidence from the trade press and from interviews conducted with managers of over 200 properties nationwide.
Policy Watch: Examining the Justification for Residential Recycling
Thomas C. Kinnaman
There are 8,875 municipalities in the United States that have initiated curbside recycling programs over the past two decades to help reduce residential solid waste. Four thousand of these municipalities encourage recycling by requiring households to pay a fee for each unit of garbage presented at the curb for collection. How beneficial have the various recycling policies been in practice? This article examines the empirical lessons gained from twenty years of solid waste policy in the United States and argues for the replacement of several state recycling mandates with a moderate landfill tax.
Recommendations for Further Reading
Timothy Taylor
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