Econ 3101Advanced Macroeconomics

Dr. Victor Li

Spring 2010

• Textbooks:

Primary: Williamson - Macroeconomics

Others: Romer, McCallum, Lecture Notes

Remark about integrating readings.• Prerequisits:

Economics – 1001,1002, 2101,2102

Math – Algebra, Multi-Variable Calculus, Linear Algebra (1500, 1505, 3400)

Math Econ - 3128• You need to be familiar AND comfortable with this level of

mathematics to do well in the course.

• Grades• Website: www.homepage.villanova.edu/victor.li• Objective: To provide an introduction to modern

methods used in macroeconomic research.

* Revisit static IS-LM macro model

* Integration of macro with micro economics

* Study the dynamic process of business cycles, economic growth, and stabilization policy.

Some Macro Facts and Issues

• Key Measures of Macroeconomic activity:

(1) GDP (level and per capita)

(2) Productivity

(3) Prices and Inflation

U.S. Output, 1869-2005

Figure 1.1 Per Capita Real GDP (in 2000 dollars) for the United States, 1900–2005

GDP Growth: 1970-2008

Macroeconomic Data and Growth Rates

• Data collected over time is often referred to as time series data. Most macro data is time series.

• Let yt = an economic variable recorded at date t

• The growth rate of y from date (t-1) to (t) is given by

• If g is a small number (even 5% is 0.05), then

111

1

t

t

t

ttt y

y

y

y

y

yyg

gg )1ln(

• Using this, we have

)ln()ln()ln( 1 yyyg ttt

• Example

Year GDP g =y/yg=ln(y)

2000 10

2001 10.25 2.5% 2.46%

2002 10.50 2.44% 2.40%

Figure 1.1 Per Capita Real GDP (in 2000 dollars) for the United States, 1900–2005

Figure 1.2 Natural Logarithm of Per

Capita Real GNP

• GDP movement can be divided into two parts: trend and cyclical.

• Trend GDP and productivity growth measures long-term economic growth.

Annual Productivity Growth1955-73 2.12%1973-98 1.67%What determines long-term growth and what

are the implications for policy?

Figure 1.2 Natural Logarithm of Per

Capita Real GNP

Figure 1.3 Natural Logarithm of Per

Capita Real GNP and Trend

Figure 1.4 Percentage Deviations from Trend in Per Capita Real GNP

Figure 1.10 Percentage Deviations from Trend in GDP, 1947–2003

• Cyclical (detrended GDP) measures the business cycle.

(i) Largest recession was GD.

(ii) Wartimes are usually associated with expansion. 1991-01 was longest peace time expansion.

(iii) Historical observations:

- Okun’s Law

- Phillip’s Curve

(iv) Business cycles are similar in terms of co-movement and timing.

Questions: What causes business cycles and what’s the role of government stabilization policy? What explains short-run versus long-run tradeoff between inflation and unemployment?

Macro Economic Theory

• Y = set of macroeconomic variables (facts)

(needs measurement)

X = set of given variables, assumptions about how economy works.

• Construction of theory: X Y• Validation of Theory

Ability to explain facts (statistical)

Theories need not be completely correct to be useful!

Economics as Social Science

• Difference between hard-sciences and social science is the lack of natural or controlled experiments.

• Models can be used to design artificial economies or economic laboratories.

The Evolution of Macro Ideas

• “A Quick Refresher Course in Macroeconomics” by N. Gregory Mankiw, Journal of Economic Literature (Dec 1990).

• “Revolution and Evolution in 20th Century Macroeconomics” by Michael Woodford, Princeton, 1999.

• Gap between “applied” and “modern” macro theory.

Applied IS-LM, Phillips CurveUsed in textbooks, forecasters, public policy making.

Modern Developments in macro research (“academic”) of the past 30-40 years.

• At some level, gap is also caused by the degree of complexity and rigor of models and the tools of analysis.

• Copernicus (heilocentric) versus Ptolemy (geocentric)

- Ultimately modern developments will change the way macroeconomists view the world and economic policy is conducted.

• Market Economics (Classical - 18th, 19th Centuries)

- Adam Smith, David Ricardo

- Free market adjustment of prices

- Classical Dichotomy

- Invisible hand, government non-intervention

• Keynesian Revolution (1930s)- “Birth” of Macroeconomics- J.M Keynes, P. Samuelson, J. Tobin- Great Depression- Failure of Markets and price system- Need for active stabilization policy- Development of basic IS-LM model and amended to include Phillips Curve(The “consensus” or “neoclassical synthesis” from 1930-70)

• 1970s: Breakdown of the consensus.

- Empirical: Failure to account for high inflation and unemployment (Philips Curve breakdown).

- Theoretical: Gap between macro and microeconomic principles.

Fails to account for how expectations affects behavior (the “Lucas Critique”)

IS-LM model is, at best, incomplete.

• Monetarism & New Classical Macroeconomics

- M. Friedman , R. Lucas, T. Sargent, N. Wallace, R. Barro.

- Economic decisions are dynamic.

- Rational expectations

- Microeconomic foundations & Market-Clearing

- Intertemporal General Equilibrium Macro Models (“Modern Macro Models”)

• Microfoundations? Another parable of Friedman and the billiard player.

• New Classical Theories

- imperfect information and money

- real business cycles

- Sectoral shifts (search unemployment)

• New Keynesian Macroeconomics

- L. Ball, G. Mankiw, D. Romer.

- Also incorporates dynamic decision making and rational expectations.

- Microeconomic foundations of sticky wages and prices (labor contracts, monopolistic competition).

• New Neoclassical Synthesis (1990s-Present)?

* Integration of Keynesian and Classical ideas into modern macro models.

* Market Clearing “Keynesian” Models (e.g., coordination failure)

* Emphasis on both real and nominal shocks.

Relation to Eco 2101

• Used IS-LM model to explain both Classical & Keynesian Theories by distinguishing between short-run and long-run.

• IS-LM as an analytical tool is at best incomplete.

* Micro-foundations for individual behavior

* Static versus dynamic

* No explicit treatment of expectations

• Objective of this course: Develop the foundations of modern macro theory and apply them to studying growth, business cycles, and economic policy.

• New Classical macro models will be emphasized:

* Benchmark model

* Led to the development of modern macro theory.

• Things you should know about measurement

- Definition and measurement of basic concepts: GDP, GNP prices, interest rates, budget

deficit, unemployment rate, ect.

- Real versus nominal and the price index as a deflator.

- Measurement of saving and wealth and relationship to investment.

Math Review

• Functions and Differentiation

• Matrices

• Systems of Equations

• Unconstrained Optimization

• Constrained Optimization

• Others