Download ECON 7020-001 Macroeconomic Theory I

MACROECONOMIC THEORY I
ECONOMICS 7020
FALL 1998
University of Colorado at Boulder
Professor JoAnne Feeney
Course Description
Topics
Economics is the study of the equilibrium allocation of resouces. In macroeconomics, we focus attention on
the aggregate allocation of resources over time. We are in particular interested in understanding the behavior
of national aggregates such as output, consumption, investment, capital accumulation, and employment. Not
only do we want to explain aggregate behavior within a country, but we also want to try to understand the
persistent differences that aggregate variables exhibit across countries. One area of primary importance to
macroeconomists concerns cross-country disparities in the per capita levels and growth rates of income.
Government fiscal policy may play a part in understanding these disparities. The study of macroeconomics
also addresses the sources of inflation and the relation between it and monetary policy. This leads us to
address the consequences of monetary policy for resource allocations over time, and, thus, for economic
growth.
Approach
It is obvious that a firm's output next year is a function of the level of investment in new equipment that is
undertaken this year. Similarly, a household's decision to borrow this year (to raise this year's consumption)
depends on how much it will have to pay in interest payments in the future. In order to explain the behavior
of output and consumption in the aggregate economy -- which is comprised of lots of households and firms -we need to understand this intertemporal dimension of economic decisions. The study of macroeconomics
thus becomes the study of aggregate equilibrium resource allocations over time.
The analysis of this decision maldng process and the consequences of it for aggregate activity and policy
outcomes requires the construction of artificial economies. These theoretical models of economic activity
will be simple representations of the more complex world we wish to understand. Model building provides
us with a laboratory in which to carry out experiments which are too costly (or impossible) to undertake in
the actual economy. A simple model allows us to focus on one particular question, and those factors that are
excluded are only those which are believed to be less important for resolving that particular question. If the
model we have created fails to explain the facts of interest or to reveal the implications of the policy under
consideration, we must reevalute the assumptions embedded in the model and try again.
We will begin in our models with the assumption that all prices (of goods and assets) are flexible and that
they adjust instantaneously so that there is never excess supply or demand (of goods or assets). We refer to
this set of models as market-clearing models. We make this assumption not because we necessarily believe
that it is true, but rather because it is useful first to understand the interdependence among macroeconomic
variables in this benchmark economy and then to proceed to a more complex world where frictions exist. A
thorough knowledge of how the market-clearing system behaves leaves us better prepared to determine the
source of existing friction s, to capture these frictions accurately in our models, and to determine their
implications.
The first term in Macroeconomic Theory explores nonstochastic models - here, we abstract from the
presence of uncertainty and its effect on economic decision making. Clearly, uncertainty about the future
must play an important role in determining current investment and saving decisions, but its omission allows
us to grasp the essentials of intertemporal choice in a considerably more simple setting. Once you have
mastered this more parsimonious dynamic economy, uncertainty will be introduced into the analysis of
economic decision making in Macroeconomic Theory II.
Relation to other Economics Fields
The techniques that you will learn in Macroeconomic Theory I (and II) are not limited in usefulness to the
study of the fields of macroeconomics. A mastery of modeling intertemporal resource allocations is
necessary for future research in the areas of international trade and finance, public finance, resource
economics, and environmental economics, to name just a few. In virtually all fields of economics, you will
encounter problems of a dynamic nature: in resource economics and environmental economics, for example,
the focus is on the depletion of some resource (oil, clean air, etc.) over time; the effects of international trade
on growth and growth on trade relies on investment decisions, research and development spillovers, and
comparative advantage shifts over time; in international finance it is important to understand international
capital flows -- to explain such cross-country investments we need to recognize that these investments take
place in order to generate future income, and we need to apply a model that incorporates this intertemporal
decision-making process. These are just a few examples of many. Consequently, you will find that the
analytical skills you learn this term and next create the necessary foundation for your future economics
courses and your future research endeavors as well.
Course Requirements
There will be three examinations - two midterms and a comprehensive final. One midterm will be held in
class and one will be a take-home exam. The take-home exam allows you the opportunity to explore fully
the technical and imaginative aspects required in modeling a problem and to connect the technical analysis
with its intuitive explanation. Make-up exams will be given only under extremely extenuating
circumstances. Notification and arrangements must be made before the exam.
Problem sets will be assigned throughout the term. Problem Sets 1 and 2 are embedded in the Supplemental
Notes (see Reading List). Other assignments will draw from a set of Review Questions that will be posted
on the course website, and others from problems in Barro and Sala-I-Martin and in Blanchard and Fischer.
The development of the skills needed to analyze macroeconomic (and other) issues requires practice in
constructing models and solving problems. The objective is to learn to understand an issue using the
simplest appropriate economic model. I strongly encourage you to form study groups and to work on these
assignments with some of your classmates; everyone must, however, hand in his or her own solution set.
The in-class midterm exam comprises 25% of your course grade, the take-home, 25%, the final exam, 35%,
and the problem sets are collectively worth the remaining 15%. The in-class midterm will be held on
Tuesday, October 6, the take-home midterm will be distributed in class on Thursday, November 5 and is due
in class at 9:30am on Tuesday, November 10. The final exam is scheduled by the College of Arts and
Science for Wednesday, December 16, 3:30pm-6:30pm.
All readings marked with an asterisk are required. The additional references are provided in the event that
you wish to learn more about one of the topics.
Questions and Answers
I will hold office hours on Tuesdays and Thursdays from 10:45am-12:00pm and from 4:45-5:30pm. My
office is Economics 102, my email address is [email protected] and my office phone is 2-5923.
Cui Ling is the TA for this class and will conduct recitations throughout the term and will hold office hours.
The times and places will be announced at the beginning of the term. Recitations will be used to go over
problem sets and answer questions.
Course Details
Textbooks
Required Texts:
Robert J. Barro and Xavier Sala-I-Martin, Economic Growth, McGraw-Hill, Inc. (BS)
Olivier Blanchard and Stanley Fischer, Lectures on Macroeconomics, MIT Press, (BF)
Recommended:
Philippe Aghion and Peter Howitt, Endogenous Growth Theory, MIT Press, 1998.
Robert Barro, Macroeconomics, 4th Edition, Wiley Press. (This book is recommended as
background reading on the market-clearing class of models.)
Robert Barro (ed.), Modern Business Cycle Theory, Harvard University Press, 1989.
(MBCT)
Avinash Dixit, Optimization in Economic Theory, Oxford University Press, 2nd Edition,
1990.
Thomas Sargent, Dynamic Macroeconomic Theory, Harvard, 1987.
Nancy Stokey and Robert Lucas, Recursive Methods in Economic Dynamics, Harvard,
1989.
Logistics
The readings will draw from the above sources and from journal articles. Required readings are marked with
an asterisk on the reading list that follows. One copy of each required journal article on this list will be on
reserve at Norlin library. One copy of the Supplemental Notes is also available on reserve. Complete
citations are given in the reading list for those that wish to copy the article from the original source at the
library .
Useful Journal Abbreviations
AER:
CJE:
EMA:
El:
FRM:
JEP:
JET:
JME:
American Economic Review
JPE:
Journal of Political Economy
Canadian Journal of Economics
QJE: Quarterly Journal of Economics
Econometrica
RES: Review of Economic Studies
Economic Inquiry
Quarterly Review, Federal Reserve Bank of Minneapolis
Journal of Economic Perspectives
Journal of Economic Theory
Journal of Monetary Economics
Course Outline and Reading List
I.
Introduction
* BF, Ch.
1
* BS, Introduction
II.
Review of the Basic Market-Clearing Model
* Supplemental Notes, sections I and II.
* Denslow and Rush, "Supply Shocks and the Interest Rate," El 1989, pp. 501-510.
III. Investment, Capital Accumulation, and Growth in Non-Monetary Economies
A. Individual Optimization Over Time: Saving and Investment Decisions, Part 1
(individual optimization over time without steady-state growth)
* Supplemental Notes, Section III
(a simple discrete-time model with infinitely-lived agents)
B. Growth through Population Expansion and Exogenous Technological Progress
I.The Solow-Swan Growth Model
(a simple look at growth that abstracts from individual optimization by assuming exogenous saving
rates)
·
* BS, Ch. 1 (excluding section 1.3)
Solow, "A Contribution to the Theory of Economic Growth," QJE, Feb. 1956.
2. Individual Optimization Over Time: Saving and Investment Decisions, Part 2
(intertemporal optimization with growth in an infinite-horizon setting with (i) infinitely-lived agents
and (ii) two-period-lived agents)
* Supplemental Notes, Section IV (a discrete-time presentation with infinitely-lived agents)
* BS, Ch. 2
* BF, Chs. 2, 3
* Lucas, "On the Mechanics of Economic Development," JME, 1988, 3-42.
IV. Investment, Capital Accumulation, and Growth in Monetary Economies
* Alan Stockman, "Anticipated Inflation and the Capital Stock in a Cash-in-Advance Economy,"
JME, 1981, 387-393.
* BF, Ch. 4
Miguel Sidrauski, "Rational Choice and Patterns of Growth in a Monetary Economy," AER
57(2), May 1967, 534-544.
Peter Diamond, "National Debt in a Neoclassical Growth Model," AER 55(5), Dec . 1965,
1126-1150.
Paul A. Samuelson, "An Exact Consumption-Loan Model of Interest with or without the Social
Contrivance of Money," JPE 66(6), Dec. 1958, 467-482.
Brock, "A Simple Perfect Foresight Monetary Model," JME, 1975, 133-150.
.
Cagan, "The Monetary Dynamics of a Hyperinflation," in M . Friedman, Studies in the Quantity
Theory of Money.
I
V.
r
Models of Endogenous Growth
* BS, Ch. 1, section 1.3, Chs. 4, 12
* Lucas, "On the Mechanics of Economic Development," JME,
1988, 3-42.
Parente and Prescott, "Changes in the Wealth of Nations," FRM, Spring 1993, 3-16.
Barro and Sala-i-Martin, "Convergence," JPE 100(2), 1992, 223-251.
Romer, "Increasing Returns and Long-Run Growth," JPE, 1986, 1002-1037.
.
Romer, "Capital Accumulation and the Theory of Long-Run Growth," Ch. 2 in MBCT.
VI. Public Policy and Economic Growth
* BF, Ch. 2.3
* Barro, "The Neoclassical Approach to Fiscal Policy," Ch. 5 in MBCT.
* Barro, "Government Spending in a Simple Model of Endogenous Growth," JPE,
1990, S 103SI25.
* King and Rebelo, "Public Policy and Economic Growth: Developing Neoclassical Implications,"
JPE, 1990, S126-Sl50.