Robert Solow has criticized our 2006 Journal of Economic Perspectives essay describing "Modern Macroeconomics in Practice." Solow eloquently voices the commonly heard complaint that too much macroeconomic work today starts with a model with a single type of agent. We argue that modern macroeconomics may not end too far from where Solow prefers. He is also critical of how modern macroeconomists use data to construct models. Specifically, he seems to think that calibration is the only way that our models encounter data. To the contrary, we argue that modern macroeconomics uses a wide variety of empirical methods and that this big-tent approach has served macroeconomics well. Solow also questions our claim that modern macroeconomics is firmly grounded in economic theory. We disagree and explain why.

Patrick J. Kehoe

V. V. Chari

English

Research Papers in Economics

NBER WORKING PAPER SERIES
THE HETEROGENEOUS STATE 
OF MODERN MACROECONOMICS: 
A REPLY TO SOLOW
V. V. Chari
Patrick J. Kehoe
WORKING PAPER 13655
http://www.nber.org/papers/w13655 
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
November 2007
We thank the NSF for financial support and Kathy Rolfe and Joan Gieseke for excellent editorial
assistance. The views expressed herein are those of the authors and not necessarily those of the
Federal Reserve Bank of Minneapolis, the Federal Reserve System, or the National Bureau of
Economic Research.
© 2007 by V. V. Chari  and  Patrick J. Kehoe. All rights reserved. Short sections of text, not to
exceed two paragraphs, may be quoted without explicit permission provided that full credit,
including © notice, is given to the source.The Heterogeneous State of Modern Macroeconomics: A Reply to Solow
V. V. Chari and Patrick J. Kehoe
NBER Working Paper No. 13655
November 2007
JEL No. E12,E13,E2,E20,E21,E22,E32,E4,E5,E52
ABSTRACT
Robert Solow has criticized our 2006 Journal of Economic Perspectives essay describing
"Modern Macroeconomics in Practice." Solow eloquently voices the commonly heard complaint
that too much macroeconomic work today starts with a model with a single type of agent. We
argue that modern macroeconomics may not end too far from where Solow prefers. He is also
critical of how modern macroeconomists use data to construct models. Specifically, he seems to
think that calibration is the only way that our models encounter data. To the contrary, we argue
that modern macroeconomics uses a wide variety of empirical methods and that this big-tent
approach has served macroeconomics well. Solow also questions our claim that modern
macroeconomics is firmly grounded in economic theory. We disagree and explain why.
V. V. Chari
Department of Economics
1035 Heller Hall
University of Minnesota
Minneapolis, MN 55455
and NBER 
chari@res.mpls.frb.fed.us
Patrick J. Kehoe
Research Department
Federal Reserve Bank of Minneapolis
90 Hennepin Avenue
Minneapolis, MN 55480-0291
and NBER 
pkehoe@res.mpls.frb.fed.usWe welcome this opportunity to respond to the comments of Robert Solow on our 2006
JEP essay. Solow eloquently voices the commonly heard complaint that too much of modern
macroeconomics starts with a model with a single type of agent. In our response we clarify that
modern macroeconomics does not end there￿ and may not end too far from where Solow prefers.
Most macroeconomic research over the last 20 years has precisely been about incorporating the
heterogeneity and the rich interactions that Solow seems to think it needs. Solow also seems to
think that essentially the only way that modern macroeconomists confront the data is through
calibration. To the contrary, a key characteristic of modern macroeconomics is the heterogeneity in
empirical strategies, including estimation, that are used to discipline the models using data. Finally,
Solow questions our claim that modern macroeconomics is ￿rmly grounded in economic theory. We
disagree and explain why.
Before we elaborate on our assertions, we must acknowledge, with gratitude, that the way we
build models and use data￿ what might be called the style of modern macroeconomics￿ owes much
to Solow￿ s seminal contributions to our profession. When he wrote down a single production function
with aggregate labor and capital in his growth model, he sacri￿ced realism for an abstraction that
has proven invaluable. In his growth accounting, he showed us how to use this abstraction in order
to provide quantitative answers to economic questions.
In his comments on our essay, Solow provides a beautiful illustration of the struggle that
engages academic macroeconomists every day. On the one hand, Solow says,
My general preference is for small, transparent, tailored models, often partial equilibrium,
usually aimed at understanding some little piece of the (macro-) economic mechanism.
On the other hand, he also says,
A modern economy is populated by consumers, workers, pensioners, owners, managers,investors, entrepreneurs, bankers and others, with di⁄erent and sometimes con￿ icting
desires, information, expectations, capacities, beliefs and rules of behavior. Their inter-
actions in markets and elsewhere are studied in other branches of economics; mechanisms
based on those interactions have been plausibly implicated in macroeconomic ￿ uctua-
tions. To ignore all this in principle does not seem to qualify as mere abstraction￿ that
is setting aside inessential details. It seems more like the arbitrary suppression of clues
merely because they are inconvenient for cherished preconceptions.
Clearly, it is impossible to have a small model which incorporates all the richness that Solow sees
in a modern economy.
So model builders need to be selective, to try to capture in their models only what is essential
in order to study the issue at hand. To do so, we design models to answer speci￿c questions, not to
reproduce the entire modern economy. Building a model to study a speci￿c question requires ￿rst
understanding the economic mechanism required to provide an answer￿ and that is easier to do, of
course, when the mechanism and the model are simple. In this sense, we share Solow￿ s preference for
￿small, transparent, tailored￿models. However, answering the kinds of macroeconomic questions
that we ask typically requires the use of general equilibrium models.
Solow seems to think that using that sort of model requires ignoring all the rich heterogeneity
which he sees in the modern economy. While that may have been true many years ago, today it is
not. Most macroeconomists today work hard to examine economic mechanisms based on the kinds
of myriad interactions that Solow seems to have in mind, and they incorporate into their models
whatever heterogeneity is needed to answer their particular questions.
We o⁄er just a few recent examples. R￿os-Rull (1996) develops a life-cycle model with con-
sumers, workers, and pensioners and uses it to ask questions about the quantitative sources of
business cycle ￿ uctuations. Krusell and Smith (1998), building on Aiyagari￿ s (1994) important con-
2tribution, develop an incomplete markets model in which heterogeneous consumers have con￿ icting
desires and use that model to ask questions about business cycle ￿ uctuations. Rogerson and Walle-
nius (forthcoming) develop a life-cycle model in which agents have di⁄erent capacities for supplying
labor and use their model to ask questions about tax rates and average employment rates across
countries. Bernanke, Gertler, and Gilchrist (1999) and Cooley, Marimon, and Quadrini (2004) de-
velop models with investors, entrepreneurs, and bankers who have con￿ icting desires and use these
models to study the role of ￿nancial constraints over the business cycle.
Macro research has thus evolved in the direction Solow might recommend. Yet that does not
rectify what seems to be his principal complaint, which has to do with the order in which we do
things. Modern macroeconomists generally start with a model with a single type of agent and then
enrich it with the details necessary to answer the question at hand. Solow prefers to start with a
model with eight types of agents and then trim away the unnecessary details, in order to end up
with a small model. To answer any particular question, though, does it really matter that we start
with a single type of agent and boost it to three types while he starts with eight types of agents
and cuts back to three? Analogies about school colors and carrots aside, there does not seem to be
much of substance here to argue about.
Solow is also critical of how modern macroeconomists use data to construct models. Speci￿-
cally, he seems to think that the only way our models encounter data is through calibration. Again,
while this may have been true years ago, today it is not. Modern macroeconomic research today
takes a wide variety of econometric approaches to confront both the micro aspects and the macro
implications of general equilibrium models with data. These approaches do include calibration, but
they also include maximum likelihood estimation, Bayesian estimation, case studies, and natural
experiments on both micro and aggregate data. We think this big-tent approach to data analysis
serves macroeconomics well: it allows us to look for clues about the quantitative magnitudes of
3various mechanisms in a wide variety of sources using a wide variety of methods.
Solow also takes issue with the claim that modern macroeconomic models are ￿rmly grounded
in economic theory. What distinguishes modern macroeconomics is its method: building models at
the level of individual households and ￿rms and using these models to attempt to answer aggregate
questions. Solow argues that any aggregate excess demand functions that are homogeneous of
degree zero and satisfy Walras￿Law are just as ￿rmly grounded in economic theory as any modern
macroeconomic model. This argument implies that building macroeconomic models from the ground
up, that is, from the level of individual households and ￿rms, has no special virtue over writing down
systems of behavioral equations. Solow￿ s argument is based on an appeal to the Sonnenschein-
Mantel-Debreu result, which implies that if we have only aggregate data, then theory imposes little
discipline on how we model aggregates. Fortunately for macroeconomics, the Sonnenschein-Mantel-
Debreu result notwithstanding, discipline is available elsewhere. If we have microeconomic data
on how individual households and ￿rms behave, then theory imposes discipline on the behavior of
aggregates over and above Walras￿Law and zero degree homogeneity.
The way macroeconomists use microeconomic data to discipline their models is still develop-
ing. Solow approvingly cites the work of Hansen and Heckman (1996), who suggest ways to improve
the process of using micro evidence to build macro models. Interestingly, Hansen and Heckman
argue that for this process to succeed, microeconomists must change the way they do business.
Indeed, Hansen and Heckman (1996, pp. 100￿ 101) contend that
much recent micro research is atheoretical in character and does not link up well with
macro general equilibrium theory. . . . A redirection of micro empirical work toward
providing input into well-de￿ned general equilibrium models would move discussions of
micro evidence beyond discussions of whether wage or price e⁄ects exist, to the intellec-
tually more important questions of what the micro estimates mean and how they can be
4used to illuminate well-posed economic questions.
We agree with Hansen and Heckman￿ s decade-old proposal. Their proposed redirection of micro
empirical work is now well under way, and it will be useful once empirical microeconomics is as
￿rmly grounded in the principles of economic theory as modern macroeconomics has been. For
promising recent examples of this redirection, see the work of Lee and Wolpin (2006) and their
references.
We don￿ t mean to suggest that the challenges facing modern macroeconomics are small.
Macroeconomists are still at the stage of ￿guring out which mechanisms are likely to be quanti-
tatively promising for answering speci￿c questions. Long before one formalizes a mechanism by
writing down a detailed model and estimates it, using statistical procedures to determine if the
mechanism is promising is desirable. Which procedure is the best for this purpose is the subject
of heated debate. While currently the most popular procedure is vector autoregressions, we prefer
another, business cycle accounting, because it relies more on economic theory. (See our 2007 work
with McGrattan.) Regardless of the speci￿cs, because it is ￿rmly grounded in economic theory,
macroeconomics is poised to make major advances on these challenges.
Near the end of his comments, Solow wonders why bright and enterprising economists are
attracted to modern macroeconomics. We think the answer is simple: the attractions of modern
macroeconomics are similar to the attractions that led Robert Solow to develop the growth model
and James Tobin to develop portfolio theory and Paul Samuelson to develop the overlapping gener-
ations model. These economists, like others before and since, were attracted to using what was then
the frontier of economic theory in an attempt to shed light on the day￿ s challenging macroeconomic
questions.
5References
Aiyagari, S. Rao. 1994. ￿Uninsured Idiosyncratic Risk and Aggregate Saving.￿Quarterly
Journal of Economics. August, 109:3, pp. 659￿ 84.
Bernanke, Ben S., Mark Gertler, and Simon Gilchrist. 1999. ￿The Financial Accelerator
in a Quantitative Business Cycle Framework.￿In Handbook of Macroeconomics, edited by John B.
Taylor and Michael Woodford, Vol. 1C, 134￿ 93. Amsterdam: North-Holland.
Chari, V. V., Patrick J. Kehoe, and Ellen McGrattan. 2007. ￿Business Cycle Accounting.￿
Econometrica, May, 75:3, pp. 781￿ 836.
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6

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