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MA2: Advanced Macroeconomics Prof. Orazio P. Attanasio Dr. Mariacristina De Nardi Academic Year 2004/2005 Aims and Objectives The aim of this course is to provide the students with an overview of some classic topics in Macroeconomics, such as consumption, investment, business cycle models, asset pricing. We will discuss some of the key facts that define each economic question, and the most recent neoclassical theories offering a framework of analysis for the above facts. We will also discuss the empirical evidence on such theories. The tools used in the course include dynamic optimization in discrete time, as applied to modern macroeconomic models. In the first week of the course we will cover some basic concepts in dynamic programming, including the Maximum Principle. In investment, we will also use continuous time techniques, for which we will provide the main tools. This will enable you to read critically most of the recent macroeconomic literature, even the more technical and rigorous articles. We will use a textbook for some of the material in the course, Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory MIT press. However, some topics will be taught using the articles in the reading list or alternative books, indicated below. Timetable and Evaluation During the course, you will be given several home-works on which you will receive feedback, but that do not matter for the final mark. Only the score of the exam, held in Term 3, will count for the final mark. However, home-works will have the same format as the final exam, so it is strongly suggested to spend plenty of time on them. The final exam is a 2 hour paper, with 2 compulsory questions out of 4. The course meets for 10 weeks in Term 2, each Wednesday 11-1 in Drayton House, starting from January 12. In the first week, to be able to cover the material on Dynamic Programming, we will also meet on Friday (14/1) from 2 to 4 in the same room. The first five weeks of the course will be taught by Professor Attanasio, while the last 5 weeks will be taught by Dr Mariacristina De Nardi. There will be four hours of classes that will be taught by Dr De Nardi. The times of the classes will be announced at a later date. Syllabus 0. Dynamic Optimization We will cover the basic tools of Discrete Time Stochastic Dynamic Programming. We will use some notes prepared by Dr Gianluca Violante. Most of this material is covered in the textbook Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory (MIT Press), which will be used throughout the course. Another useful source is Recursive Methods in Economic Dynamics, by Nancy Stokey and Robert Lucas (Harvard University Press). 1. Consumption We look at the basic facts about how consumption evolves over the life cycle and we formalize a few models to explain those features. We start from the permanent income hypothesis, and move to more recent theories of consumption demand for liquidity constraint households. Attanasio, O., “Consumption”, chapter 11, Handbook of Macroeconomics, North Holland, Elsevier. Deaton, A., Understanding Consumption, Oxford University Press, 1992. Flavin , M., “The Adjustment of Consumption to Changing Expectations about Future Income”, Journal of Political Economy, 1981, 974-1009. Hall, R., “Stochastic Implications of the Life Cycle Permanent Income Hypothesis,” Journal of Political Economy, December 1978, 971-87. Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory Chapter 16. 2. Asset Pricing In this lecture we sketch the Intertemporal Capital Asset Pricing Model and discuss some of the problems associated with it. Campbell J., “Asset Pricing, Consumption and the Business Cycle”, Handbook of Macroeconomics, chapter 19, North-Holland, Elsevier. Kocherlakota, N.: “The Equity Premium: it's still a puzzle”, Journal of Economic Literature, 1996. Hansen, L.P. and K. Jagannathan (1991): “Implications of Security Market Data for Models of Dynamic Economies”, Journal of Political Economy, 99, 225-62. Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory Chapter 13. 3. Investment We look at the basic facts on investment, drawn from aggregate data and from firm and plan level data and we formalize a few models to explain those features. We start from the neoclassical Tobin's Q model, we list its failures and we move on to more recent theories where irreversibility and uncertainty have a crucial role. Abel A. and J. Eberly, ``A Unified Model of Investment under Uncertainty'', American Economic Review, 1994, 1369-1384. Caballero, Ricardo J, Aggregate Investment, chapter 12, Handbook of Macroeconomics, North Holland, Elsevier Doms M. and T. Dunne, “Capital Adjustment Patterns in Manufacturing Plants”, Review of Economic Dynamics, 1998, pp.409-429.'' Hayashi, F., “Tobin's Marginal q and Average q: A Neoclassical Reinterpretation,” Econometrica (50), 213-224, 1982. Hubbard, Glenn, “Capital-Market Imperfections and Investment”, Journal of Economic Literature, 36(1), March 1998, pages 193-225. 4. Real Business Cycle Models In this part of the course we look at the main attempts at explaining economic fluctuations by equilibrium models, without appealing to imperfections and nominal rigidities. While not very successful, the Real Business Cycle theory has stimulated a large volume of research and has made important methodological contributions. T.F. Cooley and E.C. Prescott (1995): ''Economic Growth and Business Cycles'' in T.F.Cooley (ed.) Frontiers of Business Cycle Research, Princeton University Press. F. Kydland and E. Prescott (1982): “Time to Build and Aggregate Fluctuations”, Econometrica, 50, 1345-70. Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory Chapters 7 & 8. 5. The Government in the Neoclassical Growth Model We introduce the government in the neoclassical growth model to understand what are the effects of permanent/transitory and expected/unexpected changes in the tax regime on the equilibrium consumption and investment allocations. We ask how would taxes be set by a benevolent government who is forced to choose distortionary taxes to finance expenditures, but aims at maximizing social welfare, and through this framework we develop the basic theory of optimal taxation. Barro, Robert J., “Are government bonds net wealth?”, Journal of Political Economy, 81, 1974, pp.1095-1117. Chari V.V., Kehoe P., “Optimal Fiscal and Monetary Policy”, chapter 26, Handbook of Macroeconomics, North Holland, Elsevier. Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory Chapters 10, 11, 12 & 15. 6. Overlapping Generations: An Application to the Analysis of Social Security Reform. In this part of the course we discuss one of the work horses of macroeconomic analysis: the overlapping generation model. We also use it to discuss social security reform. Auerbach, A. and L. Kotlikoff (1987): Dynamic Fiscal Policy Cambridge University Press. P. Diamond (1965): ''National Debt in a Neoclassical Growth Model'' Journal of Political Economy, 55, 1126-1150. P. Diamond (1998): “The Economics of Social Security Reform”, NBER Working Paper No 6719. 7. Macroeconomics of Labor Markets We describe the key facts about workers and job flows in the labor market and we study equilibrium unemployment models that are consistent with those facts, essentially matching models which are equilibrium two-sided search models. The key features of these models are two: the aggregate matching function, and the Nash bargaining rule. These models generally yield allocations which are not Pareto optimal. Time permitting, we extend our analysis to competitive search models. Davis S., Haltiwanger J., and Schuh, S., Job Creation and Destruction, MIT Press, 1996. Mortensen D., and C. Pissarides, ”Job Reallocation, Employment Fluctuations, and Unemployment”, chapter 18, Handbook of Macroeconomics, North Holland. Ljunqvist and Sargent (2004): Recursive Macroeconomic Theory Chapters 6 and 26.