In his recent “A brief history of macro – how we got here” at Free Exchange, M.C.K. does a disservice to the history of the field:
- By not mentioning Milton Friedman and,
- By including the paragraph below “implying” that Friedman was the “inventor” of DSGE models:
Despite these many drawbacks, DSGE models got one big thing right: they could explain “stagflation” by pointing to people’s changing expectations. At first, a sudden unanticipated spurt of inflation could lead to rapid economic growth. Over time, however, people would come to believe that this rate of inflation would be the new normal. Real interest rates, wages, and debt burdens would eventually adjust to their old levels. The gains in employment would be temporary—eventually it would settle at its “natural rate.” Moreover, savers and investors would become increasingly wary of the government’s willingness to induce inflation and increase the risk premium they demand on long-duration assets. The government could try to make prices increase faster and faster, hoping that policy would outrun people’s rapidly-adjusting expectations, but the consequences would likely be dire.
That is exactly what Friedman said (and explained) in 1967, almost two decades before the first seed of what would over time become known as DSGE Models was planted in 1982 by Kydland and Prescott!