Theoretical and Applied Economics (Jul 2014)
New theoretical foundations for economic policy
Abstract
For four decades, economics has been confronted with two major flaws: the large theoretical gap between macroeconomic and microeconomic analysis, and the growing rates of both inflation and unemployment. Research seemed divided between two opposite approaches, searching for a new theory to solve the macro imbalances in modern economies. In this context, we start with the analysis and evaluation of the main theoretical contributions during the past decades: rational expectations, market-clearing models and rigidities. Then we investigate how this considerable theoretical progress has managed to influence economic policies. The theoretical part of the paper uses formal analysis and synthesis, comparison and interpretation regarding recent progress in economics. In the second part, we bring empirical evidence from several countries to point out the impact of these developments at the policy level. We conclude that today the ideological division seems to have vanished; new theories don’t follow a strict ideology. Theoretical research has integrated microeconomic principles into macro analysis and has addressed the macroeconomic implications of imperfections. By contrast, policy-makers still use the outdated IS-LM model together with the modern Phillips curve, they still use complex macroeconomic models for forecasts, which suggests that theoretical progress has had little impact on applied macroeconomics.
