Download 202 course paper: 2001

DEPARTMENT OF ECONOMICS
ECONOMICS 202: INTERMEDIATE MACROECONOMICS
Michaelmas Term 2001
Lecturers and Tutors: Jim Taylor and Nick Snowden.
Lectures and Classes: There will be two lectures and one class per week in this half-unit course.
The material for this course is drawn from many different sources but students will benefit from careful
reading of one of the recommended texts. These are as follows:
Main text for course:
N Gregory Mankiw Macoreconomics, 4th edition, 2000.
Alternative texts:
Brian Hillier The Macroeconomic Debate: Models of the Closed and Open Economy, Blackwell, 1991.
(This is an excellent text as far as the basic theory is concerned but suffers from a lack of applications to
illustrate the theory. An excellent book but tightly written.)
G K Shaw, M McCrostie and D Greenaway Macroeconomics: Theory and Policy in the UK, Martin
Robertson, 1997.
Supplementary texts:
K Pilbeam International Finances, Macmillan, 1994.
(Very good for international aspects of macroeconomics. The first six chapters are very relevant to this
course. These 6 chapters should definitely be part of your reading.)
Blanchard, Olivier Macroeconomics, second edition, Prentice Hall, 2000.
(This is an excellent text but has the disadvantage for the present course that it focuses rather heavily on the
US economy. It is particularly good on the role of expectations in the labour and foreign exchange markets.)
R Dornbusch, S Fischer and R Startz Macroeconomics, 7th ed.
(Solid, well written but for US market.)
K A Chrystal and S Price Controversies in Macroeconomics, third edition, Harvester and Wheatsheaf, 1994.
Specialised texts:
B Snowden and H Vane A Macroeconomics Reader, Routledge, 1997.
(This book has some excellent articles in it by world authorities in macroeconomic theory. It is up-to-date
and provides a wider perspective than is available in textbooks.)
G K Shaw An Introduction to Rational Expectations, 1984.
D Laidler The Demand for Money: Theories and Evidence.
(Excellent on the theory of the demand for money and includes a review of the empirical estimates of the
demand for money function.)
Sources of information about the macro economy:
Web sites:
You can liven up the theoretical aspects of this course by referring to current policy issues. A lot of
information is now available on the internet and I would strongly recommend you to get acquainted with
two sites which produce some very interesting material for this course. Some of you will already be familiar
with these two sites from your Part I Economics course. But do please try them.
1. www.hm-treasury.gov.uk/
This is excellent for articles relating to current fiscal and monetary policy in UK. It also provides some
excellent macroeconomic data not only for the UK but for all the world's major economies.
2. www.bankofengland.co.uk Bank of England
Particularly useful for obtaining up-to-the-minute articles by members of the Monetary Policy Committee
(MPC) and for looking through the MPC's monthly minutes. E.g. go to Publications > Speeches > Speeches
by speaker > Dr Sushil Wahdwani (and so on).
3. www.oecd.org/eco/eco
Look for Working Papers and Economic Surveys
4. www,federalreserve.gov Federal Reserve Board of the USA.
5. http://www.geoinvestor.com/
Data sources for a wide range of countries can be found at this web site.
Hard copies of macroeconomic data:
Economic Trends, Annual Supplement
Financial Statistics, Office of National Statistics
OECD Economic Outlook (bi-annual).
Objectives of Course:
This course is designed to extend the knowledge of the principles of macroeconomics which students
acquired in their first year. It is heavily oriented towards economic theory but requires this to be learned
within the context of current events in the national and international macroeconomic environment.
Considerable emphasis is placed upon the use of analytical tools for gaining a better understanding of the
workings of the macroeconomy and ways in which policy makers can respond to economic problems.
Students are encouraged to use their knowledge of macroeconomic theory to gain a better understanding of
current macreconomic events and issues.
Method of assessment:
Your final mark will be calculated as follows: one third of the final mark is determined by coursework and
two thirds by the final exam i.e. M = [0.33 x coursework] + [0.67 x mark for final exam].
Essays:
Your essay must be submitted no later than 4 pm on the last day of term. It should be noted that coursework
is compulsory. It is a departmental rule that coursework which is submitted up to 7 days after a notified
deadline will be subject to a 10 percentage point penalty, unless an extension has been previously granted.
This penalty will rise to 20 percentage points during the second 7 day period after the deadline. All work
submitted more than 14 days late after the notified deadline will be given a mark of zero.
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LECTURES
Lectures 1 & 2: The economy in the long run: the classical model of the macro-economy
(i) Classical macroeconomics: full employment equilibrium
- the assumptions of the classical model
- the component parts of the classical model
- the production function
- the labour market
- the QTM
- the loanable funds hypothesis and Say's Law.
(ii) The interaction between the component parts of the classical model
- the real economy v the money economy (the classical dichotomy).
Reading:
Mankiw, ch.3. (Chs. 1 and 2 are bedside reading.)
Hillier, Chapter 1.
Shaw et al. Chapters 7 (pages 115-125) and 8.
Discussion topics:
(i) Explain why changes in the money supply have no effect on real variables in classical theories of
employment.
(ii) How would a fall in the labour supply affect the equilibrium values of the endogenous variables in the
classical model?
(iii) How would an upward shift in the production function (eg due to technological change) affect the
equilibrium values of the endogenous variables in the classical model?
Lectures 3 & 4: The economy in the long run: the neoclassical theory of economic growth
(i) The component parts of the Solow growth model
- the aggregate supply function
- the aggregate demand for goods
(ii) Growth of the capital stock and the long-run steady state
(iii) Saving and growth
(iv) The golden rule of economic growth: maximising consumption per worker
(v) Effect of population growth on steady state output per worker
(vi) Economic growth with technical change
Reading
Mankiw, chs. 4 and 5.
Shaw, McCrostie and Greenaway, ch. on economiic growth.
Dornbusch et al. chs. 3 and 4.
Discussion topics
(i) What is the 'steady state' capital per worker?
(ii) How is the steady state output per worker determined in the Solow growth model?
(iii) What might the economy not be in its steady state equilibrium?
(iv What is the 'golden rule' of consumption per worker and how might this be achieved?
(v) Discuss the limitations of the neoclassical growth model.
(vi) Why might the growth in output per worker be endogenous? What implications does this have for the
neoclassical growth model?
Lectures 5 & 6: The macro-economy in the short run
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(i) Time horizons: aggregate supply in the short run v the long run
(ii) Fixed prices v flexible prices
(iii) Consumption, investment and aggregate effective demand: the Keynesian product market.
(iv) The demand for money: the transactions, precautionary and speculative motives.
(v) The link between the money market and the goods market: the ISLM model (rate of interest v real
income).
(vi) Deriving the aggregate demand function (price level v real income).
(vii) ISLM + aggregate demand function + aggregate supply function.
Reading
Mankiw, chs 10, 11 and 18.
Hillier, Chapters 2, 3 and 4.
Shaw et al., Chapters 5 (pages 75-86), 9 and 10.
D Laidler, Demand for Money, Chapters 4 and 5.
Discussion topics
(i) Discuss the linkages between the goods market and the money market.
(ii) Explain the factors that determine the position and slope of the IS and LM functions.
(iii) Discuss the role of the normal (or expected) rate of interest in determining the speculative demand for
money.
Lectures 7 & 8: Flexible wages and prices, the real balance effect and aggregate demand
(i) Adding a labour market to the model: Keynesian (involuntary) unemployment.
(ii) Real wage resistance: the Keynesian labour supply function.
(iii) Flexible money wages: is full employment inevitable?
(iv) The aggregate demand and aggregate supply functions.
(v) The liquidity trap and interest inelastic investment.
(vi) The real balance (or Pigou) effect: a challenge to the Keynesian prediction of persistent under-full
employment equilibrium.
(vii) The failure of the real balance effect: why is this effect likely to be weak?
Reading:
Mankiw, ch. 13.
Shaw et al., Chapter 11.
Hillier, Chapter 3.
D Patinkin, Price flexibility and full employment, American Economic Review, 1948, pp 543 - 64. (A
classic article available in various readings: M G Mueller's Readings in Macroeconomics; Lindauer's
Macroeconomic Readings: and E Shapiro's Macroeconomic: Selected Readings.
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Lectures 9 & 10: The budget constraint and the effectiveness of macro-policy
(i) Weaknesses of the simple ISLM model: the problem of lags.
(ii) Interdependence between fiscal and monetary policy instruments: the critical role of the budget
constraint.
(iii) Financing budget deficits: tax-financing, bond-financing and money financed deficits.
(iv) The balanced budget multiplier: closed and open economy models.
(v) Wealth effects of fiscal and monetary policy.
Reading:
Shaw et al., Chapter 12.
Hillier Chapter 5.
Silber, W C, 'Fiscal policy in IS-LM analysis: A correction', Journal of Money, Credit and Banking, 2,
1970.
Buiter, W H, 'Crowding-out and the effectiveness of fiscal policy', Journal of Public Economics, 7, 1977.
Blinder, A S and Solow, R M, 'Does Fiscal Policy Matter?' Journal of Public Economics. 3, 1973.
Dalamagas, 'Government deficits, crowding out, and inflation: some international evidence', Public Finance,
1987 (1).
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Discussion topics:
(i) How does the addition of a budget constraint to the ISLM model alter the predictions of changes in fiscal
and monetary?
(ii) Examine the relative effectiveness of the three methods of financing a budget deficit. Assume that
aggregate supply is (a) perfectly elastic; (b) less than perfectly elastic (i.e. there are price effects).
(iii) Examine the way in which wealth effects determine the effectiveness of fiscal and monetary policy.
(iv) Does bond-financing have wealth effects (on IS and LM)? Are these likely to be weak or strong?
Lectures 11 & 12: Monetary policy with special reference to the UK
(i) The objectives of monetary policy: stable prices, steady growth (?)
(ii) An overview of monetary policy options
(iii) Controlling monetary conditions via the money supply
- the high-powered money multiplier
- controlling high-powered money
- some problems
(iv) Controlling monetary conditions via the interest rate (the 'repo' in the UK):
- the transmission mechanism: how does the interest rate affect the economy?
(v) UK monetary policy: how does the Monetray Policy Committee operate?
Reading:
The New Monetary Policy Framework, HM Treasury, 1999. Available on the Treasury's website:
www.hm-treasury.gov.uk/
Monetary Policy in the UK, Bank of England. Available at www.bankofengland.co.uk/
The Transmission Mechanism of Monetary Policy, Bank of England website.
Shaw et al, chapter 6.
Discussion topics:
(i) How do changes in the money supply affect the real economy?
(ii) Explain and critically evaluate the high-powered money multiplier.
(iii) How does the central bank control interest rates?
(iv) What factors does the central bank take into account in setting the repo rate?
(v) How does a change in the central bank's interest rate affect the economy?
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Lectures 13 & 14: Unemployment and inflation
(i) A monetary model of inflation.
(ii) Excess demand in the ISLM model.
(iii) Interaction between wages and prices.
(iv) The Phillips curve: derivation.
(v) Short-run v long-run trade-offs: Friedman's expectations augmented Phillips curve.
(vi) The non-accelerating rate of unemployment (NAIRU).
(vii) Hysteresis: an explanation of long-term unemployment.
(viii) Incorporating the hysteresis model into the 'augmented' Phillips curve
Reading:
Mankiw, chs 7 and 13.
Shaw et al., Ch. 13.
Hillier, Ch. 6.
S Wadhwani 'British unemployment and monetary policy', Bank of England web site, 2 December 1999:
www.bankofengland.co.uk/
Nickell, S. 'Unemployment and labor markey rigidities: Europe versus North America', Journal of Economic
Perspectives, Vol. 11 (3), Summer 1997.
Nickell, S 'Unemployment: questions and some answers', Economic Journal, 1998, pp.802-816.
Vickers, J. 'Pice stability in the UK, 1999, Bank of England website (Speeches and articles section).
R Cross 'The NAIRU as a theory of unemployment', Journal of Economic Studies, vol. 20, 1993.
Chrystal and Price, Ch.2.
R Cross Unemployment, hysteresis and the natural rate hypothesis, Blackwell, Oxford, 1988.
R Cross The natural rate of unemployment, Cambridge University Press, 1995.
DeAnne Julius 'Back to the future of low global inflation,' October 1999, Bank of England website.
J Vickers 'Inflation targeting in practice: the UK experience', September 1998, Bank of England website.
S Wadhwani 'Is inflation dead?' December 1999, Bank of England website (Speeches and articles section).
Discussion topics:
(i) What factors determine NAIRU? Is this a useful concept for macroeconomic policymakers?
(ii) Does empirical evidence support the existence of a short-run trade-off between unemployment and
inflation?
(iii) Explain the concept of hysteresis as applied to the determination of long-term unemployment.
(iv) How can the concept of hysteresis be incorporated into the Phillips curve model of inflation?
Lectures 15: Expectations, new classical economics and macroeconomic policy
(i) Formation of expectations: some alternative models.
(ii) Adaptive expectations.
(iii) Rational expectations.
(iv) Policy consequences of adaptive and rational expectations.
(v) The expectations-augmented aggregate supply function.
(vi) Price expectations in macro-models: the New Classical challenge to the Keynesians.
Reading:
Mankiw, chs. 13 and 14..
Shaw et al., Chapter 13.
Chrystal and Price, Ch. 4.
Hillier, Chapters 7 and 8.
G K Shaw, Rational Expectations: An Elementary Exposition.
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Discussion topics:
(i) Explain the adaptive expectations hypothesis and comment on its major strengths and weaknesses.
(ii) Explain the rational expectations hypothesis and comment on its major strengths and weaknesses.
(iii) Compare the adaptive and rational expectations approaches to explaining the expected future value of
economic variables (such as the price level or price inflation).
(iv) Why does the aggregate supply function have a positive slope in the short-run?
(v) What implications does the adaptive expectations hypothesis have for the effectiveness of demand
management policies?
(vi) Does acceptance of the rational expectations hypothesis imply that attempts to manage demand are
doomed to failure?
Lectures 16 &17: The open economy model
Fixed v floating exchange rate regimes
The current and capital accounts of the balance of payments
The elasticity and absorption approaches to the BP
The exchange rate and domestic absorption
Internal v external equilibrium
Reading:
Mankiw, ch. 8.
Pilbeam, chs. 1,2 and 3.
Shaw, Ch. 14.
Hillier Ch. 9.
Discussion topics:
(i) Distinguish between the various definitions of the exchange rate.
(ii) What factors determine the demand and supply for a currency?
(iii) Distinguish between the price and output effects of a devaluation.
(iv) Why might a devaluation worsen the current account in the short run?
(v) What circumstances are required for a devaluation to work?
(vi) Distinguish between internal and external balance and discuss the policy tools available for correcting
different types of internal and external imbalance.
(vii) What factors determine the position and slope of the BP function?
Lecture 18: Macro-policy in an open economy: fixed v floating exchange rates and fixed v flexible
prices
(i) The fixed price model with fixed and floating exchange rates
(ii) The flex-price model with fixed and floating exchange rates
(iii) The effects of fiscal and monetary policy under fixed exchange rates
(iv) The effects of fiscal and monetary policy under floating exchange rates
Reading:
Mankiw, ch.12.
Pilbeam, Ch. 4.
Shaw, Ch. 14.
Hillier, Ch. 10.
Discussion topics
(i) What are the implications of (a) immobile, (b) imperfectly mobile and (c) perfectly mobile capital flows
for the operation of the Mundell-Fleming model?
(ii) Compare the relative effectiveness of fiscal and monetary policy under fixed and floating exchange rates
in the Mundell-Fleming model.
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Lectures 19 & 20: Theories of exchange rate determination: over-shooting of the exchange rate (the
Dornbusch model)
(i) The determination of exchange rates in the long run: purchasing-power parity
(ii) The determination of exchange rates in the short run: trade flows and capital movements
(iii) Over-shooting of exchange rates to monetary shocks in the short run
Reading:
Pilbeam, Ch.6 and 7.
Shaw, Ch. 15
Discussion topics:
(i) What is purchasing power parity (PPP)?
(ii) Explain the purchasing power parity approach to the determination of exchange rates and discuss its
weaknesses.
(iii) Explain the Dornbusch model of exchange rate over-shooting. Why might exchange rates over-shoot in
the short run when the domestic money supply is increased relative to other countries?
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ESSAY
Write an essay on one of the following questions. The essay must be no more than 2000 words and must
be handed in no later than 4.00 pm on the last day of term. Please remember to include a complete list of
references including chapters of books and articles in journals which have been used.
Please read through your essay carefully before handing it in. If necessary use a dictionary (or the spell
check on your computer). Please check that the print quality is good, otherwise the essay will be returned
unmarked.
Note: You must not copy from textbooks without using quotation marks. It is also essential that you
do not simply precis the original text. Write the essay in your own words. This is crucial.
1. Explain and critically evaluate the view that downward price flexibility will automatically return an
under-employed economy to full employment equilibrium even in the absence of active fiscal and monetary
policies.
2. Critically evaluate the ways in which central banks could in theory exercise control over monetary
conditions.
3. Discuss the relevance and importance of the government's budget constraint in determining the
consequences of planned changes to government spending and taxation.
4. Is the concept of the non-accelerating inflationary rate of unemployment of any value to policymakers?
5. Discuss different ways in which expectations of future price levels may be formed and evaluate their
implications for the effectiveness of demand management policy.
6. Explain and critically appraise the Dornbusch model of exchange rate over-shooting.
7. Does the concept of purchasing power parity have any value for explaining movements in a country's
exchange rate?
8. Does the real balance effect undermine the Keynesian prediction of under-full employment
equilibrium
in situations of persistent demand deficiency?
9. Identify the possible causes of the simultaneous fall in unemployment and inflation during the 1990s.
10. In what sense might a country have a serious structural problem with its balance of payments even
though the latter is in equilibrium?
11. Explain the role of the savings rate in the neoclassical growth model. In the context of this model,
why might the government want to influence the savings rate?
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IMPORTANT INFORMATION
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It is the responsibility of each student to keep an exact back-up copy in a readily accessible format
of all work submitted for assessment purposes.
All students will, without exception, be required to take the examination relating to this course in
the summer of 1998.
The University's regulation relating to plagiarism is as follows:
'Plagiarism occurs when a candidate appropriates the thoughts, writings or results of another, and
presents these as his/her own. Assessed work ... must be the candidate's own work, and
acknowledge both assistance given and major source(s) involved. All forms of plagiarism are
considered serious academic offences...'
The Economics Department will view any such activities as an extremely serious matter for which
penalties will be imposed. Such penalties may include the award of a zero mark for the piece or
pieces of work in question.
All coursework must be submitted by the notified deadline, otherwise penalties will be imposed.
Details are available from the Department of Economics Office.
All coursework is to be submitted ONLY via the Economics Department Office (B34 of the
Management School) where it will be date-stamped upon receipt. In the event that the office is
closed coursework must be submitted via the essay box, located in the mixing bay, opposite the
Departmental Office.
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