"Damn, it's Kydland and Prescott. Not good for Keynes", I wrote an SMS to Rizal last night. I learned macroeconomics from Stephen Parente, a former student of Ed Prescott, and his co-author for "Barriers to Riches". Steve is really proud of him -- and of Finn Kydland (also a former student of Prescott). He took three consecutive meetings to talk about Kydland-Prescott's time inconsistency model. (I had a chance to meet Prescott when he was giving a lecture on the causes of difference in productivity between American and European workers. It was boring).
Back to what gives Kydland and Prescott the Nobel. It's that time (in)consistency model. It's about credibility of policy. It is THE real business cycle. The more Steve taught me about Real Business Cycle, the more I appreciated that elegant model (Steve likes the example of credibility in monetary policy: once you deviate, you're screwed). But... the more I read the paper the more I was and am questioning the plausibility of its key assumption. I am always skeptical when people start saying "... in infinite horizon..". Infinite? Gimme a break. This is what Keynes really hated. Hiding behind infinite horizon. Loooooooooonnnnnggggg run. And mind you, in that infinite horizon, there is only one representative consumer. How come? Isn't that too heroic an assumption?