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r ... Economics 6080 Applied Macroeconomic Theory Fall 1993 - Robert McNown Text : R . E. Hall and J . B. edition) W.W. Norton . Taylor, Macroeconomics, 1993 (fourth Supplemental Readings: Articles listed below are available through Campus Copies in Norlin Library (Packet #16). Topics and Readings: I . Overview of macroeconomic perspectives interest . Hall and Taylor, Chapters 1 - 3. and variables of II . Model of long run equilibrium. Hall and Taylor, Chapters 4-5. III. Short run fluctuations, aggregate demand, and the ISLM model. Hall and Taylor, Chapters 6-11. Midterm Examination IV. The open economy and models with government policy . Hall and Taylor, Chapters 12-14, 18-19. R.J. Barro, "The Ricardian Approach to Budget Deficits, " Journal of Economic Perspectives vol. 3 (Spring 1989) 37-54 . V. Critique of ISLM and alternative perspectives . R . G. King, "Will the New Keynesian Macroeconomics Resurrect the IS-LM Model?" Journal of Economic Perspectives vol. 7 (Winter 1993) 67-82. c. I. Plosser, "Understanding Real Business Cycles," Journal of Economic Perspectives vol . 3 (Summer 1989) 51-78. N. G. Mankiw, "Real Business Cycles : A New Keynesian Perspective," Journal of Economic Perspectives vol. 3 (Summer 1989) 79-90 . VI. Dynamic Macroeconomics. Hall and Taylor, Chapters 15-17 . A. Chiang, Fundamental Methods of Mathematical Economics 1984 (third edition), McGraw Hill, Chapters 16-17 . Final Examination Course Content During the 1950s and 1960s the Keynesian view of macroeconomics dominated the economics profession and policy circles. Weaknesses in the Keynesian model became apparent with the coexistence of high unemployment and price inflation during the 1970s and the failure of Keynesian based econometric models to predict macroeconomic fluctuations during this period . Simultaneously, the Keynesian model was criticized for an inadequate treatment of expectations and weak microeconomic foundations. This critique has led to the development of alternative "new classical" and real business cycle models by some economists, while others have tried to shore up the Keynesian approach by incorporating rational expectations and firmer microeconomic foundations. Given the unsettled state of macroeconomics today , one goal of this course is to present a balanced perspectiv e of the comp eting schools of macroeconomic thought . A second goal is to develop the tools of macroeconomic analysis that are essential to understanding more advanced courses in macroeconomics and for policy analysis . The applied component of the course relies on the computer simulation program (MacroSolve) that accompanies the text by Hall and Taylor. Al though the models embodied in MacroSol ve cannot capture the full complexity of an economy, exercises with these models provide some understanding of how computer simulation models are used to analyze policy alternatives . Throughout the course you will be required to analyze macroeconomic data and run simulations as suggested by the text . In addition, you will present as a larger term project of your own design, which could also be based on a simulation exercise . This project should focus on a particular issue of policy or macroeconomic principles. Ideas for this exercise might come from the reading assignments or the popular press . Examples that would be amenable to simulation· analysis include ( i) · the effects of exchange rate regime on fiscal or monetary policy effectiveness, (ii) how the formation of i nflationary expectations affects the adjustment of the economy to its long run equilibrium, (iii) the analysis of supply-side shocks on the time path of prices, interest rates, and unemployment . In addition to performing the simulations that illustrate your problem, you must present a theoretical (mathematical and/or v erbal) explanation of the economic events shown in the simulation . If you can connect your simulation to recent or historical events in the U. S . or other economies, this would certainly enhance the quality of your project. As you begin to work with MacroSolve and learn of its capabilities and limitations, you will gain a better idea of the possibilities for this project. You are invited to submit a proposal for the project or to discuss your idea at any time . The project will be due on the last day of our class, with a 20 % penalty for late submissions. Your grade in the course will be based on a midterm exam and final e x am and the simulation projects . Each componen t will count equally towards the final grade . MacroSolve Exercise I Productivity Change in the U.S. A. Introduction to MacroSolve. Read the Appendix : Introduction to MacroSolve and experiment with the features of this program. Take note of the variables that are available in the database . To become familiar with data manipulation, plotting and printing with MacroSolve, work exercise 2 on page 65 of the text. You will first need to CREATE the requested ratios, then do the analysis in parts a and busing these ratios. (You will notice that any variable you create will be lost when you terminate your MacroSolve session. Therefore you will want to complete your use of any created series during that session.) What is the advantage of working with these ratios to GDP, rather than performing the analysis with the original data? Submit the graphs requested in part b, together with your answers to the specific questions in part b. B. Solow's computation of technological change. In the article cited in Section 4. 4 of the text, Solow presented estimates of the rate of change in U.S. productivity using equation (4-7). All variables in this equation except technology (A) are measurable and available in MacroSolve. Technology (or its rate of change) is then computed as a "residual." Submit relevant computer output with your answers to the questions below. CREATE the percentage changes of the two inputs. After you select the CREATE command from the DATA menu, Fl will give you explicit instructions and examples for creating new series. Your equation for creating the rate of change in capital stock, for example, should look like CAPGR = (CAPITAL - CAPITAL[-1))/(CAPITAL[-l)*O.Ol) The indicated parentheses and brackets must be used as shown, but the program will give a friendly reminder if you make a mistake. Next residual, TECHCH = compute the rate of growth in productivity as the %GDP - 0.7*EMPGR - 0.3*CAPGR where EMPGR and CAPGR are the names given to the input rates of change. Tabulate and plot TECHCH, and get a printout of this graph. In the real business cycle literature, TECHCH is sometimes called the "Solow residuals," and this series is central to the analysis of business fluctuations and growth. Your assignment is to perform some critical, independent analysis of the Solow residuals as a foundation for real business cycle analysis. First, consider the plausibility of the signs and magnitudes of these year-to-year changes in productivity . Does your computed series match your prior beliefs about annual variations in productivity? Support y our reasoning with particular observations of your computed TECHCH series . Second, consider the relation between economic fluctuations and the Solow residuals . The basic tenet of the real business cycle school is that productivity shocks cause business cycles. Examine the relation between TECHCH and some business cycle measures, such as the rate of unemployment or the GNP gap. Look at these relations graphically and examine the correlations between your series (F2 option in the PLOT menu) . Experiment with lagging one series behind the other as an indication of the direction of causation (do productivity shocks precede business fluctuations?) . Other than the real business cycle interpretation of the relation between TECHCH and economic fluctuations, what other explanations could be advanced for the observ ed relations? Based on your investigations of the data, which explanation do your prefer? Explain, citing your evidence.