Macroeconomic Policy in a World Economy: From Econometric Design to Practical Operation.

• Author: Lee, Jim

This monograph articulates John Taylor's contributions to macroeconometric policy evaluation and design since the late 1970s. Yet, the book is not simply a collection of his previously published articles; instead, it is a well-organized premier for the new-Keynesian approach to macroeconomics. The author attempts to merge the fundamentals of the Keynesian tradition in modeling with the theoretical developments since the rational expectations revolution. He accomplishes this objective by demonstrating the feasibility of using a prototype model tractable by individual researchers, as opposed to large-scale models, to deliver scientific answers to practical questions in macroeconomic policymaking.

Taylor's pedagogy involves building three frameworks with varying degrees of complexity and computational difficulty to reflect the issues addressed. In search of a world-economy model in Chapter 3, he progressively develops a preliminary stylized two-country model and then an intermediate VARMA model of five linear equations for the U.S. economy. For each model, he carefully demonstrates model construction, its estimation technique, simulation results, and provides policy analysis. Such treatments highlight the significance of different modeling strategies: modeling and computational costs versus econometric performance. For instance, while the VAR estimation method is feasible of estimating the closed-economy model, the multicountry model can only be estimated using the single equation FIML method. Nevertheless, even Taylor's "workhorse"--the world-economy model with ninety-eight stochastic equations for the G-7 countries--is still conceptually manageable.

The models are prototypical of the new Keynesian approach. Their main features consist of rational expectations, staggered wage- and price-determination mechanisms, and forward-looking consumer behavior. This framework contributes to the dynamics of long-run neutrality (monetary policy) as well as complete crowding out (fiscal policy) and persistent short-run fluctuations with a trade-off between the variances of inflation and real output. The treatments in the international sector include the Mundell/Flemming theory of perfect capital mobility as well as time-varying risk premia in foreign exchange and capital markets. In line with the recent developments in the time consistency and policy credibility theories, Taylor redefines policy rule as a "well-defined contingency plan in a dynamic...