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Conventional Macroeconomic Wisdom: A Caveat
Por: David Andolfatto

1 Introduction

In order to conduct monetary policy, central bankers (and/or the people they draw on for policy advice) must have some view as to how an economy functions. Any such view is necessarily based on some theory of how the world works. What exactly is this theory and what are its logical underpinnings?
A theory consists of three main ingredients. First, there is a set of phenomena for which an explanation is desired (endogenous variables). For central bankers, these variables are primarily inflation and output (GDP). Second, there is a set of phenomena that are believed to influence the set of endogenous variables, but which are viewed as being determined by forces beyond the central bank's control (exogenous variables). Some examples here include various events that are labelled as ‘shocks;' as in an ‘oil supply shock,' or an ‘aggregate demand shock.' Third, there exists some mapping that relates how the set of endogenous variables depends on the set of exogenous variables [1] .

It is sometimes difficult to get a handle on the precise structure of the theory that governs policy actions at the highest level of a central bank's hierarchy. A part of the problem here is that any such theory exists primarily in the head of central bankers themselves and is rarely made explicit to us. Perhaps this is because the real world in which central bankers must operate is sufficiently complicated as to make the mapping that relates exogenous and endogenous variables hopelessly complicated. Or perhaps central bankers have a strategic motive for being deliberately vague in their policy statements. Sometimes this ambiguity manifests itself in a humorous/frustrating way; consider the following quotations attributed to Federal Reserve Chairman Alan Greenspan:

"I know you believe you understand what you think I said, but I am not sure you realize that what you heard is what I meant."

"I guess I should warn you, if I turn out to be particularly clear,you've probably misunderstood what I've said."

Things are not quite so bad as these quotes suggest. There are ways to make educated guesses at how central bankers view the world by studying the language they employ (which reveals how they were trained in economics and/or who they listen to for policy advice). Furthermore, there is a branch of the academic literature that attempts to formalize the logical underpinnings of this language. This language has become so common place among central bankers, policy analysts, newspaper commentators and among an influential group of academics that I label it the ‘conventional wisdom.' In what follows, I review the nature of this conventional wisdom and offer a critique that I hope will motivate some thoughtful reflection.

[1] More precisely, this component of a theory consists of a set of rules instructing us how to construct such a mapping.
* I would like to thank, without implicating, John Chant, Ken Kasa, and Peter Kennedy for their helpful comments and criticisms.