Natural Concepts in Macroeconomics - Ray C. Fair.PDF

Natural Concepts in Macroeconomics Ray C. Fair∗ June 2005 Abstract Ragnar Frisch proposed in 1936 a procedure for estimating natural vari- able values by modifying what are now called structural macroeconometric models. This paper shows that Frisch’s procedure can be used to illuminate natural concepts using today’s models. The procedure also forces one to be precise regarding the assumptions used in moving from a short-run model to a medium-run or long-run model. 1 Introduction Natural concepts play an important role in macroeconomics. Wicksell (1898) originated the idea of a natural rate of interest, and recently there has been renewed interest in this concept.1 Friedman (1968) and Phelps (1968) originated the idea of a natural rate of unemployment, and a huge literature developed from this work. From early on economists have struggled with defining and measuring natural values. An early attempt at this is in an important paper by Frisch (1936). At the ∗Cowles Foundation and International Center for Finance, Yale University, New Haven, CT 06520-8281. Voice: 203-432-3715; Fax: 203-432-6167; e-mail: ray.fair@yale.edu; website: fairmodel.econ.yale.edu . I am indebted to William Brainard for helpful comments. 1See Bomfim (1997), Orphanides and Williams (2002), Laubach and Williams (2003), and Woodford (2003). 1935 meeting of the Econometric Society, Frisch, Breit, F.G. Koopmans, Marschak, and Tinbergen had discussions of Wicksell’s concept of the natural interest rate and more generally of what was to be “understood by a ‘natural’ or ‘equilibrium’ position of a certain set of economic variables.”2 Frisch’s paper is an outcome of this discussion. This is a fascinating paper for its time, and I argue