Intermediate Macro Texts and Notes Recommended for Background Review:
-
L. Tesfatsion, "U.S. National Income and Product Accounting: Basic Definitions and Concepts"
(html)
-
L. Tesfatsion, "Price, Employment, and Productivity Terms and Concepts"
(html)
- Andrew Abel and Benjamin S. Bernanke, Macroeconomics, Addison-Wesley, latest available edition. [A good
all around intermediate-level introduction to macro.]
- Robert Barro, Macroeconomics, John Wiley and Sons,
latest available edition. [An intermediate-level macro text
that stresses the New Classical approach (flexible prices with continual market clearing and rational expectations) for a closed economy.]
- Robert Hall and John Taylor, Macroeconomics, W. W. Norton & Company, latest available edition. [An intermediate-level macro text that stresses the New Keynesian approach (sticky prices with possible labor market disequilibrium) for an open economy. A complete quantitative macroeconomic model is constructed, and a computer implementation (MacroSolve) of this model is provided.]
- M. Gregory Mankiw, Macroeconomics, Worth Publishers, latest available edition. [This best-selling intermediate macro text stresses a blend of New Keynesian and New Classical ideas. It uses simple verbal and graphical presentations, with most mathematics relegated to appendices (and exercises).]
- Wallace C. Peterson and Paul S. Estenson, Income, Employment, and Economic Growth, W. W. Norton & Co., New York, latest available edition [An intermediate-level macro text that is more discursive and less analytical than
Abel/Bernanke, Barro, or Hall/Taylor; strong on historical perspective and comparisons of competing schools of
thought.]
Topics, Discussion Questions, and Readings
Please Note: A double asterisk ** means that a reading
contains basic required material for answering exam questions and
exercises. A single asterisk * means that a reading contains
recommended material of a more general contextual nature that could be
useful for answering exam questions and exercises.
All readings with double and single asterisks are listed in a
suggested reading order. Each required (double asterisk) reading can be obtained
either in the required course packet, as a class hand-out, or on-line.
The form of availability for each reading is indicated after its
citation information. Suggested readings for more specialized study
are also given for each topic area.
Updated or new materials (required or recommended readings,
discussion questions, exercises, exam guides,...) may be added to
the on-line syllabus at a later time. Such materials will be marked
on the syllabus with an "updated" or "new" icon, respectively, for
at least one week, and their inclusion will also be announced in
class.
Finally, in the readings cited below, the expression
op. cit. is an abbreviation for the Latin expression
opere citato, which means "in the work cited (above)."
I. INTRODUCTION
- COURSE OVERVIEW
Key Questions for In-Class Discussion:
- What is "macroeconomics"?
- What issues will this course address?
- What are some of the key approaches macroeconomists had been taking to the theoretical study of macroeconomic systems prior to the 2007-2009 economic crisis? Are these approaches now discredited? In need of major revision? Still viable?
Required Readings:
- [**] L. Tesfatsion, "What is Macroeconomics All About?"
-
[**] Wim Meeusen, "Whither the Microfoundations of Macroeconomic Theory?"
(pdf,293KB),
Brussels Economic Review, 54(1), Spring 2011, 51-80.
[Note: Skim briefly for now; study more carefully as the course proceeds and included topics are covered in class.]
Recommended Readings:
-
[ *] "Symposium: Macroeconomics after the Financial Crisis", Journal of Economic Perspectives (JEP), Volume 24, No. 4, Fall 2010, pages 3-102. (Articles by Robert H. Hall, Michael Woodford, Lee E. Ohanian; Andreas Fuster et al., and Ricardo J. Caballero)
-
**Important Note:**
- The following five perspectives by well-known economists present five distinctly different views regarding the changing state of macroeconomic theorizing since the publication of Keynes' General Theory of Employment, Interest, and Money in 1936. These perspectives make particularly interesting reading because each was written in the years immediately preceding the 2007-2009 economic crisis. At this point I recommend that you simply skim through the articles to get a general sense of what is claimed. More careful readings of these articles could then profitably be done at a later time after we have covered more of the discussed topics in class.
- [ *] Michael Woodford, "Revolution and Evolution in Twentieth Century Macroeconomics
(pdf, 119KB),
presented at the conference Frontier of the Mind in the Twenty-First Century, Library of Congress,
Washington, D.C., June 1999.
-
[ *] N. Gregory Mankiw,
"The Macroeconomist as Scientist and Engineer"
(pdf,102KB),
Journal of Economic Perspectives, Vol. 20, No. 4, Fall 2006, 29-46.
- [ *] Edmund S. Phelps, "Macroeconomics for a Modern Economy"
(pdf,128KB),
Nobel prize lecture, Stockholm, Sweden, December 10, 2006.
- [ *] W. Brian Arthur, Steven Durlauf, and David Lane, "Introduction"
(pdf,53KB),
in W. B. Arthur, S. Durlauf, D. Lane (Eds.), The Economy as an Evolving Complex System II, Addison Wesley, Reading, MA, 1997.
- [ *] Axel Leijonhufvud, "Agent-Based Macroeconomics"
(pdf,93KB),
Chapter 36 (pp. 1626-1637) in L. Tesfatsion and K. Judd (Eds.), Handbook of Computational Economics, Volume 2: Agent-Based Computational Economics, Handbooks in Economics Series, North-Holland/Elsevier, 2006.
Other Suggested Readings and Websites
- EMPIRICAL CHARACTERISTICS OF THE U.S. ECONOMY
Key Questions for In-Class Discussion:
- Historical facts about the U.S. economy
- How did the U.S. economy weather the 2007-2009 economic crisis?
- What lessons might be drawn from this crisis for the study of macroeconomics?
- Comparison of U.S. time-series data for key macroeconomic variables under Presidents Bush, Obama, and Trump (to date).
[**] Take-Home Exercise 1 (Individual): Construction of Macroeconomic States
(pdf,66KB).
Due: Friday, September 1, 12:10pm (beginning of class).
Required Readings:
-
[**] "Key U.S. Historical Benchmarks".
-
[**] Empirical Data Packet 1: Basic Concepts and Times Series Data for the U.S. Economy.
-
[**] Empirical Data Packet 2: Financial Crises and the US Great Recession (2007-2009)
(SlideSet,pdf,2.5MB).
-
[**]
Empirical Data Packet 3: Comparison of U.S. time series data for key macroeconomic variables under Presidents George W. Bush, Barak H. Obama, and Donald J. Trump (through October 2017)
(pdf,922KB).
-
[**] Charles I. Jones, "The Global Financial Crisis: Overview"
(pdf,214KB),
a Supplement to Macroeconomics
(W.W.Norton), May 22, 2009.
Recommended Readings:
-
[ *] Charles I. Jones and Paul M. Romer, The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital
(pdf,337KB),
American Economic Journal: Macroeconomics, Vol. 2, Issue 1, 2010, 224-245.
-
[ *]
L. Tesfatsion, "U.S. National Income and Product Accounting: Basic Definitions and Concepts"
(html)
-
[ *]
L. Tesfatsion, "Price, Employment, and Productivity Terms and Concepts"
(html)
-
[ *]
Peter Radford, "Whither Economics? What Do We Tell the Students?"
(pdf,32KB),
Real-World Economics Review, 52(10), March 2010, 112-115.
-
[ *]
Building a Science of Economics for the Real World, Committee on Science and Technology, U.S. House of Representatives, July 20, 2010, Congressional Testimony given by
Brad Miller,
Robert Solow,
Sidney Winter,
Scott Page,
David Colander,
and
V.V. Chari
-
[ *] Kristopher Gerardi, Andreas Lehnert, Shane Sherlund, and Paul Willen, "Making Sense of the Subprime Crisis"
(pdf,494KB),
Brookings Papers on Economic Activity, Fall 2008.
-
[ *] The
U.S. Congressional Budget Office (CBO)
provides current budget and economic information about the U.S. economy, as well as its most current Budget and Current Outlook report projecting
the future state of the U.S. economy over the next several years.
-
[ *] Andrew Abel and Benjamin S. Bernanke, op. cit., introductory chapter titled
"Introduction to Macroeconomics", and Hall and Taylor, op. cit.,
introductory chapter titled "Economic Growth and Fluctuations".
Other Suggested Readings and Websites
-
BASIC MACROECONOMIC MODELING CONCEPTS
Key Questions for In-Class Discussion:
- What do macroeconomists mean by the "state" of an economy? By "social welfare"?
- Tailoring models to particular economic concerns
- What makes macro modeling so difficult to do well!!!
- Different strokes for different folks, or one universal way?
- What is the "Walrasian General Equilibrium (WGE)" model that underlies
so much of current macroeconomic theorizing?
- How is individual welfare measured in the WGE? How is social welfare measured?
- Elements of dynamic economic modeling
Required Readings:
-
[**] L. Tesfatsion, "Universal Economic Principles?"
-
[**] L. Tesfatsion, "Introduction to Walrasian General Equilibrium Modeling
(pdf, 148KB),
(SlideSet,474KB)
- Note: The Packet version of this material (but not the online version) contains a figure depicting the basic structure of a WGE model and an appendix providing a detailed quantitative illustration of a WGE model. As will be seen throughout the remainder of the course, the WGE model (in an extended dynamic form) is the principal paradigm underlying current mainstream macroeconomic theory.
- [**] L. Tesfatsion, "Elements of Dynamic Economic Modeling: Presentation and Analysis," Sections 1-3
(pdf,642KB)
Recommended Reading:
- [ *] Kartik B. Athreya, Big Ideas in Macroeconomics: A Nontechnical View, MIT Press, 2013, 432pp.
Abstract: Athreya (Federal Reserve Bank of Richmond, an ISU undergrad) starts by reviewing in detail the Walrasian general equilibrium model and its dynamic extension, the Arrow-Debreu-McKenzie model, as an important basis for current mainstream macroeconomic models. In subsequent chapters, among other topics, he provides a spirited (and controversial) defense of the use of rational expectations and equilibrium assumptions in macroeconomic modeling. This book has ignited the blogosphere, both for and against.
Other Suggested Readings and Websites
II. AGGREGATE AD/AS MACROECONOMIC MODELING: A MICROFOUNDATIONS CRITIQUE
- THE BASIC AGGREGATE DEMAND (AD) MODEL: IS-LM
Key Questions for In-Class Discussion:
- What are the strengths and weaknesses of AD modeling?
- Why does AD modeling continue to influence the language and practice of policymakers (e.g., the U.S. Economic Report of the President) despite its rejection by many mainstream macroeconomic theorists?
[**] Take-Home Exercise 2 (Individual): Effects of an Increase in the Income Tax Rate
(pdf,91KB).
Due: Friday, September 8, 12:10pm (beginning of class).
Required Readings:
- [**] L. Tesfatsion, "The Economy as a Circular Flow".
- [**] L. Tesfatsion, "The Basic Short-Run IS-LM Model with Sticky Prices".
- Note: The
basic sticky-price IS-LM model as presented and motivated in
Abel/Bernanke and Hall/Taylor, below. A careful review of the
indicated chapters from at least one of these texts is highly
recommended. Abel/Bernanke is recommended for more advanced students,
and Hall/Taylor is recommended for students with weaker
macro backgrounds.
Recommended Readings:
-
[ *] F. Brayton, T. Laubach, D. Reifschneider (2014), "The FRB/US Model: A Tool for Macroeconomic Policy Analysis"
(html)
- [ *] Review either Abel/Bernanke, op. cit. (Part 1:Introduction;
Part 2: Long-Run Economic Performance; and Part 3: Business Cycles and
Macroeconomic Policy), or Hall/Taylor, op. cit. (Part 1: Introduction;
Part 2: Long-Run Fundamentals; and Part 3: Economic Fluctuations).
- [ *] J.M. Keynes, The General Theory of Employment, Interest, and Money, Harcourt, Brace \& World, 1965 Edition, Chapters 1-3, 8-15, and 18.
- Note: This is the claimed source of the basic IS-LM model -- judge for yourselves.
Other Suggested Readings and Websites
-
AGGREGATE SUPPLY (AS) AND PRICE ADJUSTMENT
Key Questions for In-Class Discussion:
- How can the basic single-period IS-LM model be augmented with supply-side aspects and dynamic price adjustment relationships (e.g., an expectations augmented Phillips curve) to permit circular-flow modeling and the tracking of the state of the economy over time?
- How can the resulting dynamic IS-LM model be used to illustrate basic dynamic modeling concepts, such as state-space modeling, classification of variables, and dynamic parameter sensitivity analyses?
- How can the resulting dynamic IS-LM model be used to illustrate the important role played by price adjustments ("sticky" versus "flexible") and expectation formation ("adaptive" versus "rational") in the determination of macroeconomic policy effects?
[**]
Take-Home Exercise 3: Effects of an Increase in the Income Tax Rate in a Dynamic Sticky-price IS-LM Model
(pdf,115KB).
Due: Friday, September 15th, 12:10pm (beginning of class).
Required Readings:
- [**] L. Tesfatsion, "Aggregate Supply and Price Adjustment: The
Dynamic Sticky-Price IS-LM Model".
- Note: The general idea of price adjustment
in response to excess supply or demand via a Phillips
Curve relation, as presented and motivated in Abel/Bernanke
and Hall/Taylor, below. A careful review of the
indicated chapters from these texts is highly recommended.
- [**] L. Tesfatsion, "A Dynamic Sticky-Price IS-LM Model,"
- [**] L. Tesfatsion, "The Dynamic Sticky-Price IS-LM Model: An
Illustrative Exercise,"
- [**] L. Tesfatsion, "Adaptive versus Rational Expectations"
- [**] L. Tesfatsion, "A Dynamic Flexible-Price IS-LM Model with Rational Expectations"
- [**] L. Tesfatsion, "Policy Experiments with Two Versions of the Dynamic IS-LM Model: Sticky-Price Vs. Flexible Price"
Recommended Readings:
- [ *] Robert Hall and John B. Taylor, op. cit., chapters titled "The Adjustment
Process" and "Macroeconomic Policy".
- Note: These Hall and Taylor chapters discuss macro policy analysis using a
relatively simple form of an expectations-augmented Phillips curve.
These chapters are particularly recommended for study/review for students
with relatively weak macro backgrounds.
- [ *] Andrew Abel and Benjamin S. Bernanke, op. cit., chapter titled
"Unemployment and Inflation".
- Note: More advanced discussion than Hall and Taylor (above) of labor market
and price adjustment issues using an expectations-augmented Phillips curve.
This chapter is highly recommended to all students for study/review.
- [ *] Symposium on "Is There a Core of Practical Macroeconomics We Should All Believe In?", American Economic Review (Papers & Proceedings), May 1997, pp. 230-246.
- Note: Five short articles responding to the symposium question by five well-known economists of different persuasions circa 1997: Rober Solow, John Taylor, Martin Eichenbaum, Alan Blinder, and Olivier Blanchard. This should be interesting to (re)read from the vantage point of the 2007-2009 economic crisis!
Other Suggested Readings and Websites
-
CRITIQUES OF AGGREGATE AD/AS MACROECONOMIC MODELING: SUMMARY OVERVIEW
Key Questions for In-Class Discussion:
- Microfoundations Issues
- Expectations Modeling Issues
- Coordination Issues
Required Reading:
- [**]
L. Tesfatsion, "Microfoundations Critique of AD/AS Models: Wealth, Savings, and Accounting Identities"
- Note: These notes discuss the substantial changes in standard AD/AS models that would have to be made in order to obtain a logically consistent stock-flow modeling of wealth, savings, and accounting identities.
III. ECONOMIC GROWTH: A MICROFOUNDATIONS
APPROACH
-
GROWTH, WEALTH, AND INEQUALITY OVERVIEW
Key Questions for In-Class Discussion:
- Measured in terms of real per capita GDP, the poorest countries of the
world have an average growth rate of about 1%, whereas the average for
the richest countries is about 3.5%. Why so much concern about a 2.5%
difference?
- Why have some countries been able to sustain high
economic growth rates while other countries have not?
- Why are some countries wealthy and other countries poor?
- What is the relationship between growth, wealth, and inequality?
- Why are many economists in agreement that a theoretical framework is needed to think seriously about growth, wealth, and inequality?
- Can growth, wealth, and inequality be satisfactorily explained purely in terms of economic factors?
- What does empirical evidence suggest are the primary determinants of growth, wealth, and inequality?
Required Reading:
-
[**] Peter Howitt and David Weil, Economic Growth
(pdf,71KB),
Palgrave Dictionary of Economics, 2008.
Recommended Readings:
-
[ *] Charles I. Jones, The Facts of Economic Growth
(pdf,1.8MB),
Chapter 1 (pp. 5-69) in Handbook of Macroeconomics, Volume 2A, John B. Taylor and Harald Uhlig, Eds., Handbooks in Economics Series, Elsevier, 2016.
-
[ *] Martin Ford, Rise of the Robots: Technology and the Threat of a Jobless Future, Basic Books, NY, 2015.
- Abstract: As noted by a commentator from the Financial Times, this study is "well-researched and disturbingly persuasive."
-
[ *] Thomas Piketty, Capital in the Twenty-First Century, translated by Arthur Goldhammar, Harvard University Press, Cambridge, MA 2014.
-
[ *] Special Section on Growth, Wealth, and Inequality: Summaries and Critiques of Thomas Piketty's Capital in the 21st Century
(pdf,1.9MB),
Journal of Economic Perspectives, Winter 2015, pp. 1-88.
Other Suggested Readings and Websites
-
DYNAMIC ECONOMIC MODELING CONCEPTS
Key Questions for In-Class Discussion:
- Analysis of ordinary differential/difference equation (ODE) systems
- Existence, uniqueness, and stability of ODE system solutions
- Specification and solution of stochastic dynamic optimization problems
Required Readings:
- [**] L. Tesfatsion, "Elements of Dynamic Economic Modeling: Presentation and Analysis," Sections 4-7
(pdf,642KB).
- [**] L. Tesfatsion, "Notes on Differential Equations", stress on parts discussing existence, uniqueness, and stability of stationary solutions.
Recommended Readings:
- [ *] Warren B. Powell, Clearing the Jungle of Stochastic Optimization
(pdf,692KB),
INFORMS Tutorial, June 8, 2014.
- Abstract: "While deterministic optimization enjoys an almost universally accepted canonical form, stochastic optimization is a jungle of competing notational systems and algorithmic strategies. This is especially problematic in the context of sequential (multistage) stochastic optimization problems, which is the focus of our presentation. In this article, we place a variety of competing strategies into a common framework which makes it easier to see the close relationship between communities such as stochastic programming, (approximate) dynamic programming, simulation, and stochastic search.... The result is a single coherent framework that encompasses all of these methods, which can often be combined to create powerful hybrid policies to address complex problems."
Note: The above Powell tutorial is an exceptionally lucid exposition of stochastic dynamic optimization, based on the author's 30 years of practical experience. It should be studied with care by every would-be PhD economics student before taking any PhD macroeconomic theory courses, since macroeconomies are now routinely modeled as dynamic stochastic systems of intertemporally optimizing agents. One important caution: The Powell tutorial only addresses stochastic optimization as a game against nature undertaken by a single optimizer (e.g., a "representative consumer"). Games involving multiple strategically interacting players are not considered.
- [ *] Robert Barro and Xavier Sala-i-Martin, Economic Growth, op. cit, Appendix on Mathematical Methods, pp. 462-517.
- Note: This appendix provides an excellent summary presentation of many of the main mathematical
methods currently used in economic growth theory: differential equations; static optimization; dynamic optimization in continuous time (Pontryagin's method making use of the Hamiltonian); matrix algebra; and useful results from the calculus (e.g, implicit function theory, integration by parts, and so forth). It is highly recommended for students planning to pursue a Ph.D. in economics (after a study of the above Powell tutorial).
- [ *] Russell Cooper, "Dynamic Programming: An Overview"
(pdf,19pp),
February 14, 2001.
- Note: This overview provides a basic introduction to dynamic programming, illustrated by economic examples. It is highly recommended for students planning to pursue a Ph.D. in economics (after a study of the above Powell tutorial).
- [ *] Gianluca Violante, "Notes on Discrete Time Stochastic Dynamic Programming"
(pdf,14pp),
Spring 2000.
- Note: This overview provides a more advanced technical introduction to dynamic programming,
including careful presentations of the Banach fixed pointed theorem, Blackwell's Sufficiency theorem, and so forth. The overview should be accessible to students with a good background in advanced calculus. It is highly recommended for students planning to pursue a Ph.D. in economics (after a study of the above Powell tutorial).
-
DESCRIPTIVE GROWTH MODELS
Key Questions for In-Class Discussion:
- What are the basic issues the one-sector Solow-Swan (SS) descriptive growth model is meant to address?
- How does the SS model compare and contrast with the Walrasian general equilibrium model?
- How does the SS model compare and contrast with the (flexible/sticky-price) dynamic IS-LM Model?
- What are the basic predictions of the SS model
regarding short-run and long-run growth rates of economies?
- How has the SS model been extended to include technological change? factor
markets?
- Are the properties of the one-sector SS model robust to an
extension to two or more sectors (i.e., two or more
distinct produced goods)
[**]
Exercise 4 (Individual):
Effects of Income Tax Rate Changes in a Solow-Swan Descriptive Growth Model
(pdf,113KB).
Due: Friday, September 22, 12:10pm (beginning of class).
Required Readings:
-
[**] L. Tesfatsion, "The Basic Solow-Swan Descriptive Growth Model"
(pdf,432KB).
- [**] L. Tesfatsion, "Summary: The Basic Solow-Swan Descriptive Growth Model" (Summary of Key Properties and Predictions).
-
[**]
Robert M. Solow, Growth Theory and After
(html),
Prize Lecture on the occasion of the award of the Sveriges Riksbank Prize In Economic Sciences in Memory of Alfred Nobel, 1987, plus an Addendum added in 2001.
-
[**] Robert Solow, Reflections on Growth Theory
(pdf,44KB),
pp. 3-10 in P. Aghion and S. N. Durlauf (Eds.), Handbook of Economic Growth, Volume 1A, Elsevier B.V., 2005.
- Abstract:
"This note contains some general and idiosyncratic reflections on the current state of neoclassical growth theory. It expresses some surprise at the lack of attention both to multi-sector growth models and to multi-country models with trade and capital flows. It also suggests that there might be value in further analysis of some old topics like
capital-labor substitution with an expanded definition of capital, and the interaction of growth and medium-run phenomena (or, to put it differently, the interaction of demand-side and supply-side variations)."
Recommended Readings:
- [ *] Andrew Abel and Benjamin S. Bernanke, op. cit., SECOND HALF of Part-2 chapter titled "Long-Run Economic Growth", which reviews the basic Solow-Swan Descriptive Growth Model.
- [ *] Robert Barro and Xavier Sala-i-Martin, op. cit., chapter titled "Growth Models with an Exogenous Savings Rate" (advanced discussion of the Solow-Swan Descriptive Growth Model).
- [ *] David Romer, op. cit., chapter titled "The Solow Growth Model" (advanced discussion).
- [ *] Jonathan Temple, "Aggregate Production Functions and Growth Economics"
(pdf,267KB),
International Review of Applied Economics 20(1), July 2006, 301-317.
- Note: Rigorous approaches to aggregation indicate that aggregate production functions do not exist except in unlikely special cases. This paper considers the awkward implications
for growth economics. It provides a conventional defence of growth theory in terms of `parables' and then considers how empirical growth research might avoid the need for aggregate production functions.
-
[ *] L. Tesfatsion, "Notes on the Existence of Aggregate Production Functions"
(pdf,157KB).
- Abstract: These notes summarize the stringent necessary conditions determined by Franklin Fisher and other researchers for the existence of an aggregate production function of the form Y = F(K,L) as used in many standard macroeconomic models (e.g., AD/AS models, Solow-Swan growth models, Ramsey optimal growth models, and overlapping generations models).
-
OPTIMAL GROWTH MODELS
Key Questions for In-Class Discussion:
- Basic Issue: What happens when the simple Keynesian savings function
in the Solow-Swan descriptive growth model is replaced by
a "representative" optimizing consumer who chooses a consumption/savings
path over time to maximize his lifetime utility?
- How can the resulting "optimal growth model" be expressed
in analytically tractable form?
- What is the economic interpretation of this optimal growth model?
- What are the advantages and limitations of growth models (descriptive and optimal) from a theoretical viewpoint? from an empirical viewpoint?
[**]
Exercise 5 (Individual):
Introductory Exercise on the Basic Optimal Growth Model
(pdf,125KB).
Due: Friday, October 13, 12:10pm (beginning of class).
Required Readings:
-
[**] L. Tesfatsion, "A Simple Illustrative Optimal Growth Model"
(pdf,407KB).
- [**] L. Tesfatsion, "Notes on Hyperbolic Discounting".
Recommended Readings:
- [ *] Robert Barro and Xavier Sala-i-Martin, op. cit., chapter titled "Growth Models with Consumer Optimization -- the Ramsey Model" (advanced discussion).
- [ *] David Romer, op. cit., "optimal growth" sections of Chapter titled "Infinite Horizon and Overlapping Generations Models" (advanced discussion).
- [ *] Shane Frederick, George Loewenstein, and Ted O'Donoghue, "Time Discounting and Time Preference: A critical Review", Journal of Economic Literature, Volume XL, Number 2, June 2002, pp. 351-401. (See, in particular, the first four sections of this article.)
-
OVERLAPPING GENERATIONS MODELS
Key Questions for In-Class Discussion:
- What are the key defining properties of the n-period lived
overlapping generations (OG) model of an economy?
- What important classes of economic problems can be addressed using this
type of model?
- Why is it that the trading activities of private agents in
the basic OG economy do not necessarily result in Pareto efficient or even productively efficient outcomes?
[**]
Exercise 6 (Individual):
Introductory Exercise on Intertemporal Optimization
(pdf,96KB).
Due: Friday, October 20, 12:10pm (beginning of class).
[**]
Exercise 7 (Individual):
Exploring the Implications of a Social Security System in a Simple Overlapping Generations Economy
(pdf,99KB).
Due: Friday, November 3, 2017, 12:10pm (beginning of class).
Required Readings:
- [**] L. Tesfatsion, "The Basic Pure-Exchange Overlapping
Generations Economy".
-
[**] L. Tesfatsion, "Game Theory: Basic Concepts and
Terminology"
(pdf,35KB).
Important Note: Only pages 1-11 of these game theory materials are required reading for the current Section III.E. The remaining pages will be required reading for the later Section VI.A on macroeconomic coordination issues.
Recommended Readings:
- [ *] Gary Becker, "Family Economics and Macro Behavior"
American Economic Review 78 (March 1988), 1-13 (Presidential Address).
- [ *] David Romer, op. cit., "overlapping generations" sections of chapter titled "Infinite Horizon and Overlapping Generations Models" (advanced discussion).
IV. TREATMENT OF EXPECTATIONS IN MACROECONOMIC MODELS
-
RATIONAL VS. ADAPTIVE EXPECTATIONS
Key Questions for In-Class Discussion:
- What are the essential distinctions between rational and adaptive expectations?
- What is meant by "weak form" versus "strong form (Muthian)" rational expectations?
- What are the implications of rational vs. adaptive expectations assumptions regarding the types of uncertainty that can be considered and addressed in macro models?
- Why is it often difficult to solve explicitly for a "rational
expectations" solution?
- Why kinds of logical and practical difficulties are posed by the fact rational expectations solutions can fail to exist or can fail to be unique?
[**]
Take-Home Exercise 8 (Individual): Introductory Exercise on Rational Expectations
(pdf,105KB).
Due: Friday, Nov 10, 12:10pm (beginning of class).
Required Reading:
[**] L. Tesfatsion, "Introductory Notes on Rational Expectations"
(pdf,287KB).
Recommended Readings:
- [ *] Axel Leijonhufvud, "Towards a Not-Too-Rational Macroeconomics", Chapter 3 (pp. 39-55) in David Colander (ed.), Beyond Microfoundations: Post Walrasian Macroeconomics, Cambridge University Press, Cambridge, UK, 1996.
- Note: Leijonhufvud contrasts current macroeconomic theory -- the study of "incredibly smart people in unbelievably simple situations" -- with what he believes ought to be the subject of macroeconomic theory: namely, the study of "believably simple people (coping) with incredibly complex situations."
- [ *] Alan Blinder, "Keynes, Lucas, and Scientific Progress",
American Economic Review
(pdf, 969KB),
77 (May 1987), pp. 130-136.
- [ *] Robert E. Lucas, Jr., and Thomas Sargent, "After Keynesian
Macroeconomics"
(pdf,1.4MB),
Chapter 7 (pp. 166-180) in T. M.
Havrilesky, Modern Concepts in Macroeconomics, Harlan-Davidson, Illinois, 1985.
- Note: This reprint of a famous 1978 conference talk includes the provocative assertion (p. 1) that the "Keynesian doctrine" is "fundamentally flawed" and its predictions are "wildly incorrect." It dramatically heated up the Keynesian vs. rational expectations debate in the late 1970s and 1980s.
Other Suggested Readings and Websites
-
IMPLICATIONS FOR POLICY CHOICE OVER TIME
Key Questions for In-Class Discussion:
- What is meant by a "government policy rule"?
- What is the Lucas Critique?
- Why might it be advantageous for a government to act in accordance with
policy rules rather than engage in discretionary policy choice?
- Why are credible commitment and time inconsistency problems of concern to
government macroeconomic policy makers?
Required Reading:
-
[**] L. Tesfatsion, "Notes on the Lucas Critique, Time Inconsistency and Related Issues"
(pdf,122KB).
Recommended Reading:
- [ *] "Rational Expectations: Retrospect and Prospect: A Panel Discussion with Michael Lovell, Robert E. Lucas, Jr., Dale Mortensen, Robert Shiller, and Neil Wallace"
(pdf,186K),
Moderated by Kevin Hoover and Warren Young, CHOPE Working Paper No. 2011-10, Duke University, 30 May 2011.
Other Suggested Readings and Websites
V. DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM (DSGE) MODELS AND TAYLOR RULES
-
INTRODUCTION TO DSGE MODELING
Key Questions for In-Class Discussion:
- General structural features of DSGE models?
- Connections to other types of macro models?
- Taking DSGE models to the data: What are the many DSGE external shock terms and strong prior restrictions meant to represent in reality?
- Re-evaluation of macro theorizing needed in view of the 2007-2009 economic crisis -- no longer a question, but an urgent priority!
Required Readings:
-
[**] Extended Set of In-Class DSGE Discussion Questions
(pdf,57KB)
-
[**] Argia M. Sbordone, Andrea Tambalotti, Krishna Rao, and Kieran Walsh, Policy Analysis Using DSGE Models: An Introduction
(pdf,618KB),
FRBNY Economic Policy Review, Federal Reserve Bank of New York, October 2010.
-
[**] Michael T. Kiley, "Macroeconomic Modeling of Financial Frictions for Macroprudential Policymaking: A Review of Pressing Challenges"
(pdf,49KB),
FEDS Notes, Federal Reserve Bank, Washington, D.C., May 26, 2016.
-
[**] Paul Romer, The Trouble with Macroeconomics
(pdf,1.2KB),
The American Economist, 2016. See, also, Romer's update to this article (in response to received comments)
here.
Recommended Readings:
- [ *] Ricardo J. Caballero, "Macroeconomics After the Crisis: Time to Deal with the Pretense of Knowledge Syndrome"
(pdf,563KB),
Journal of Economic Perspectives 24(4), Fall 2010, 85-102.
- Abstract: The author argues that the economics profession has been in "fine-tuning" mode within the local-maximum of the DSGE world whereas the profession should instead be in a "broad-exploration" mode.
-
[ *] Mervyn King, "Uncertainty and Large Swings in Activity"
(pdf,2.5MB),
National Bureau of Economic Research Reporter, No. 3, September 2017, pp. 1-10.
- Abstract: The author (a former governor of the Bank of England and Alan Greenspan Professor of Economics at New York University) reviews how the stochastic one-sector (DSGE) models so prevalent today came to dominate macroeconomic thinking. He then argues that these models have two fundamental limitations: reliance on expected utility theory, based on fragile probabilistic foundations unsuitable for situations of radical uncertainty; and an exclusive focus on the aggregate demand level rather than on its composition. He illustrates his concerns "with a rapid tour of some of the relevant data."
-
[ *] Alan P. Kirman, "Whom or What Does the Representative Agent Represent?"
(pdf,2.2MB),
Journal of Economic Perspectives 6(2), Spring 1992, 117-136.
- Abstract: The Kirman article has been a highly influential critique of the use by DSGE macroeconomic theorists (among others) of a single "representative consumer" to represent the consumption sector of a macroeconomy.
- [ *] Jana Kremer, Giovanni Lombardoy, Leopold von Thaddenz, and
Thomas Werner, "Dynamic Stochastic General Equilibrium Models
as a Tool for Policy Analysis"
(pdf,161KB),
CESifo Economic Studies, November 28, 2006, 26pp.
- Abstract: This article surveys the state-of-the-art in mainstream macroeconomic policy modeling right before the
2007-2009 global economic crisis. In particular, it favorably reviews
the use of dynamic stochastic general equilibrium (DSGE) models as a tool for policy analysis.
- [ *] Jesper Lindé, Frank Smets, and Raf Wouters, "Challenges for Central Banks' Macro Models
(pdf,2MB),
Chapter 28 (pp. 2186-2262) in John B. Taylor and Harald Uhlig, Eds., Handbook of Macroeconomics, Vol. 2B, Handbooks in Economics Series, Elsevier:Amsterdam, 2016.
- Abstract:
"In this chapter, we discuss a number of challenges for structural macroeconomic models in the light of the Great Recession and its aftermath. It shows that a benchmark DSGE model that shares many features with models currently used by central banks and large international institutions has difficulty explaining both the depth and the slow recovery of the Great Recession. ... (E)xtensions go some way in accounting for features of the Great Recession and its aftermath, but they do not suffice to address some of the major policy challenges associated with the use of nonstandard monetary policy and macroprudential policies."
- [ *] David Romer, "Dynamic Stochastic General-Equilibrium Models of Fluctuations"
(pdf,401KB),
Chapter 7 from David Romer, Advanced Macroeconomics, 4/e, McGraw Hill, 2012.
- [ *] Frank Smets and Raf Wouters, "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area"
(pdf,570KB),
National Bank of Belgium Working Paper, 2003, Stress on Sections 1, 2, and 6.
- Remark: The Smets-Wouters DSGE model has been used by the European Central Bank over the past several years to analyze macroeconomic policy for the Euro area, i.e., the particular set of European countries that have commonly adopted the Euro as their currency.
-
[ *] Frank Smets and Raf Wouters, "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach"
(pdf,443KB),
American Economic Review, Vol. 97, No. 3, June 2007, 586-606.
- [ *] L. Tesfatsion, "The Household Sector in the Smets-Wouters DSGE Model: Comparisons with the Standard Optimal Growth Model"
(pdf,41KB).
- [ *] Camilo E. Tovar, "DSGE Models and Central Banks"
(pdf,270KB),
BIS Working Paper No. 258, Bank for International Settlements, September 2008, 29pp.
- Remark: The BIS is now famous for being one of the few agencies to issue strong warnings about excessive risk taking in financial markets in advance of the economic and financial crisis of 2007-2009.
-
TAYLOR RULES AND CENTRAL BANK MONETARY POLICY
Key Questions for In-Class Discussion:
- What is meant by a "Taylor Rule"?
- How have Taylor Rules been incorporated into DSGE models to date?
- Post-crisis analysis: Are Taylor Rules enough for monetary policy makers?
Required Reading:
- [**] Athanasios Orphanides, "Taylor Rules"
(pdf,105KB),
in S. Durlauf and L. Blume (Eds.), New Palgrave Dictionary of Economics, Revised Edition, Palgrave Macmillan, London, 2008.
Recommended Readings:
-
[ *] Flint Brayton, Thomas Laubach, and David Reifschneider (2014), "Optimal-Control Monetary Policy in the FRB/US Model"
(html)
- [ *] Committee on the Global Financial System (CGFS), "Macroprudential Instruments and Frameworks: A Stocktaking of Issues and Experiences"
(pdf, 183KB),
CGFS Papers No. 38, Bank for International Settlements, May 2010.
- Abstract: Traditionally, macroeconomic fiscal and monetary policies (e.g., Taylor monetary policy rules) have focused on maintaining high employment and keeping inflation in check. The goal of macroprudential policy, recently advocated by the Bank for International Settlements (BIS) and other financial institutions, is the mitigation of systemic risk, defined to be disruptions to financial services entailing serious negative consequences for the real economy. Researchers at the BIS were among the first to warn about the pending financial crisis back in 2007.
-
[ *] William B. English, J. David Lopez-Salido, Robert J. Tetlow, "The Federal Reserve's Framework for Monetary Policy: Recent Changes and New Questions"
(pdf,649KB),
IMF Fourteenth Jacques Polak Annual Research Conference, Nov. 7-8, 2013.
- Abstract:
"In recent years, the Federal Reserve has made substantial changes to its framework for monetary policymaking by providing greater clarity regarding its objectives, its intentions regarding the use of monetary policy -- including nontraditional policy tools such as forward guidance and asset purchases -- in the pursuit of those objectives, and its broader policy strategy. These changes reflected both a response to changes in economists’ understanding of the most effective way to implement monetary policy and a response to specific challenges posed by the financial crisis and its aftermath, particularly the effective lower bound on nominal interest rates. We
trace the recent evolution of the Federal Reserve's framework, and use a small-scale macro model and a simple static model to help illuminate the approaches taken with nontraditional
monetary policy tools. A number of foreign central banks have made similar innovations in response to similar developments."
-
[ *] Peter Howitt,
"What Have Central Bankers Learned from Modern Macroecononomic Theory?"
(pdf preprint,338KB),
Journal of Macroeconomics, Vol. 34, Issue 1, March 2012, 11-22.
- [ *] John B. Taylor, "Discretion Versus Policy Rules in Practice"
(pdf,1.7MB),
Carnegie-Rochester Conference Series on Public Policy 39, 1993, pp. 195-214.
VI. MACROECONOMIC MODELING OF ENDOGENOUS COORDINATION
-
COORDINATION ISSUES FOR MACROECONOMIES
Key Questions for In-Class Discussion:
- Must economic equilibrium necessarily entail Walrasian market
clearing?
- What does "coordination failure" mean for a macroeconomy? How
is it distinct from disequilibrium?
- Can economies become stuck
in situations with persistently positive "involuntary" unemployment?
- Can unemployment arise in macroeconomies for reasons other
than sticky prices?
- Why might credible signalling of purchasing intentions be important in
circular flow economies?
- How might coordination failure arise in the presence of behavioral
uncertainty?
- What kinds of institutions (private or public) might help to
induce coordination on socially desirable outcomes?
[**]
Take-Home and In-Class Exercise 9 (Individual): From Rugged Individualism to Brother's Keeper: What Constitutes a ``Just'' Resource Allocation Mechanism?
(pdf,106KB).
Due: Thursday, November 30th, 11am (beginning of class).
Required Readings:
-
[**] L. Tesfatsion,
"Walrasian General Equilibrium: Benchmark of Coordination Success?"
(pdf,72KB).
-
[**] L. Tesfatsion, "Game Theory: Basic Concepts and
Terminology"
(pdf,35KB).
Important Note: Pages pages 1-11 of these game theory materials were required reading for the earlier Section III.E. The remaining pages of this game theory packet are required reading for the current Section VI.A.
-
[**] L. Tesfatsion, "NonWalrasian Equilibrium: Illustrative
Examples", Sections 1, 2, 3, and 6 only:
(pdf,315KB).
Recommended Readings:
- [ *] Samuel Bowles and Herbert Gintis, "Walrasian Economics in
Retrospect"
(pdf,205KB),
Quarterly Journal of Economics, November 2000, 1411-1439.
- Abstract:
"Two basic tenets of the Walrasian model, behavior based on self-interested exogenous preferences and complete and costless contracting, have recently come under critical scrutiny. First, social norms and psychological dispositions extending
beyond the selfish motives of Homo economicus may have an important bearing on outcomes, even in competitive markets. Second, market outcomes depend on strategic interactions in which power in the political sense is exercised. It follows
that economics must become more behavioral and more institutional. We can return to these themes of the classical tradition, now equipped with the more powerful mathematical tools developed over the past century."
-
[ *] John C. Driscoll and Steinar Holden,
"Behavioral Economics and Macroeconomic Models"
(pdf,337KB),
Staff Working Paper 2014-43, Federal Reserve Board, Washington, D.C., 2014.
- Abstract: The authors survey efforts to use behavioral economics to improve some of the underpinnings of the New Keynesian DSGE model. Specifically, they discuss consumption, the formation of expectations, the determination of wages and employment that underlie aggregate supply, and the possibility of multiple equilibria and asset price bubbles.
-
[ *]
Andrew G. Haldane, The Dappled World
(pdf,2.3MB),
GLS Shackle Biennial Memorial Lecture, Bank of England, 10 November 2016.
- Abstract:
Although (the recent) crisis in economics is a threat for some, for others it is an opportunity -- an opportunity to make a great leap forward, as Keynes did in the 1930s. For the students in this room, there is the chance to rethink economics with as clean a sheet of paper as you are ever likely to find. That is perhaps why the numbers of students applying to study economics has shot up over recent years. This is one of the silver linings of the crisis. No discipline could ask for a better endowment. But seizing this opportunity requires a re-examination of the contours of economics and an exploration of some new pathways. That is what I wish to do in this lecture."
Other Suggested Readings and Websites
-
CONSTRUCTIVE MODELING OF ENDOGENOUS COORDINATION:
AGENT-BASED MACROECONOMICS
Key Questions for In-Class Discussion:
- What is agent-based computational modeling and how might it facilitate the study
of macroeconomic systems?
- Key coordination issues that are being experimentally studied using agent-based computational tools:
- Learning effects (under what conditions will expectations come to be
coordinated?)
- Interaction effects (under what conditions will buyers and sellers
efficiently match and trade? Under what conditions will social norms and conventions
emerge as shared perceptions?)
- Effects of institutional scaffolding (hindrance or help for achieving macroeconomic coordination on "good" outcomes)
Required Readings:
- [**] L. Tesfatsion, "Elements of Dynamic Economic Modeling: Presentation and Analysis," Sections 8-11
(pdf,642KB).
-
[**] L. Tesfatsion, "Agent-Based Macroeconomics: Constructive Modeling of Decentralized Market Economies"
(SlideSet,2.1MB).
- Note: This slide set discusses the potential of Agent-based Computational Economics (ACE) modeling tools for the study of macroeconomic systems. Points are illustrated using an ACE model of a two-sector decentralized market economy. The presentation is based on "Agent-Based Computational Modeling and Macroeconomics" listed below as a recommended reading.
-
[**] Blake LeBaron and Leigh Tesfatsion, "Modeling Macroeconomies as Open-Ended Dynamic Systems of Interacting Agents"
(pdf,45KB),
American Economic Review (Papers & Proceedings), Volume 98, No. 2, 2008, 246-250.
- Abstract: This short essay discusses the potential applicability of Agent-based Computational Economics (ACE) for macroeconomic modeling, with a particular stress on the following three issues: (1) taxonomy - what types of agents for macroeconomic models?; (2) scale robustness - how many agents for macroeconomic models?; and (3) empirical validation - connecting to data.
-
[**] Michael Woodford, "What's Wrong With Economic Models?"
(pdf,383KB),
Institute for New Economic Thinking, July 2012.
- Abstract:
The author, a well-known contributor to the DSGE modeling approach, concludes his paper (p. 8) with the following advice and prediction: "(Economists should) make the best way of modeling people's beliefs about the economy's future evolution an important topic of inquiry along with the other determinants of economic outcomes. The shift in perspective will have important consequences for the way that we seek to validate and parameterize our models, and likely even farther-reaching consequences for the way that models are used to assess policy proposals."
Recommended Readings:
-
[ *] Robert Axtell, "Very Large-Scale Multi-Agent Systems and Emergent Macroeconomics"
(SlideSet,pdf,559KB),
Lecture Slides, The Brookings Institution, Washington, D.C., 2005.
-
[ *] Robert Axtell, "Zipf Distribution of U.S. Firm Sizes"
(pdf,132KB),
Science 293(5536), 2001, 1818-1820.
-
[ *] Ekaterina Sinitskaya and Leigh Tesfatsion, "Macroeconomies as Constructively Rational Games"
(Working Paper, pdf,1.2MB),
Journal of Economic Dynamics and Control 61 (December 2015), 152-182.
- Abstract:
"Real-world decision-makers are forced to be locally constructive; that is, their decisions are necessarily constrained by their interaction networks, information, beliefs, and physical states. This study transforms an otherwise standard dynamic macroeconomic model into an open-ended dynamic game by requiring consumers and firms with intertemporal utility and profit objectives to be locally constructive. Tested
locally-constructive decision processes for the consumers and firms range from simple reactive reinforcement learning to adaptive dynamic programming (ADP). Computational experiments are used to explore macroeconomic performance under alternative decision-process combinations relative to a social planner benchmark solution. A key finding is that simpler decision processes can outperform more sophisticated decision processes such as ADP. However, memory length permitting some degree of adaptive foresight is critical for good performance."
-
[ *] L. Tesfatsion, "Agent-Based Computational Modeling and Macroeconomics"
(pdf,148KB),
pp. 175-202 in David Colander (ed.), Post-Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006.
On-Line Resources for Agent-Based Macroeconomics
-
REACHING FOR THE STARS: THE PLACES WE COULD GO!
Key Issues for In-Class Discussion:
- Clear model design principles
- Comprehensive empirical validation
- Standardized "policy readiness levels" for model development
- Standardized presentation protocols
- Edgier explorations for critical real-world systems
- Spectrum of experiment-based modeling approaches from 100% human subjects to 100% computational agents
Required Reading:
-
[**] L. Tesfatsion, "Modeling Economic Systems as
Locally-Constructive Sequential Games"
(SlideSet,pdf,1MB).
- Note: This slide presentation is based on an article with the same title published in a 2017 issue of the Journal of Economic Methodology. The article is listed below as a recommended reading.
Recommended Readings:
-
[ *] Robert Axelrod and Leigh Tesfatsion, An On-Line Guide for Newcomers to Agent-Based Modeling in the Social Sciences
(html)
-
[ *] Matteo Richiardi, "The Future of Agent-Based Modelling"
(pdf,323KB),
Working Paper, Institute for New Economic Thinking, Nuffield College, Oxford, UK, June 2015.
- Abstract:
The author elaborates on the role of agent-based modeling (ABM) for macroeconomic research. His main tenet is that the full potential of the ABM approach, not yet realized, lies in the modular nature of ABMs. He envisions the foundation of a
Modular Macroeconomic Science, where new models with heterogeneous interacting agents, endowed with partial information and limited computational ability, can be
created by recombining and extending existing models in a unified computational framework.
-
[ *] L. Tesfatsion, "Modeling Economic Systems as
Locally-Constructive Sequential Games"
(WP,pdf,679KB),
(SlideSet,pdf,1MB),
Journal of Economic Methodology, Vol. 24, Issue 4, 2017, 384-409.
- Abstract:
Real-world economies are open-ended dynamic systems consisting of heterogeneous interacting participants. Human participants are decision-makers who strategically take into account the past actions and potential future actions of other participants. All participants are forced to be locally constructive, meaning their actions at any given time must be based on their local states; and participant actions at any given time affect future local states. Taken together, these essential properties imply real-world economies are locally-constructive sequential games. This paper discusses a modeling approach, Agent-based Computational Economics (ACE), that permits researchers to study economic systems from this point of view. ACE modeling principles and objectives are first concisely presented and explained. The remainder of the paper then highlights challenging issues and edgier explorations that ACE researchers are currently pursuing.
-
[ *] L. Tesfatsion, Agent-Based Macroeconomics Website
(html)
