Intermediate Macroeconomics [Econ 402 SP2012]

This site contains relevant guidelines for Econ 402, Spring 2012. Students are asked to regularly check this course website for updates and most recent information. This site will grow with the semester and it will contain a section with a brief description of what we have learned in previous classes and what we will cover in the next one.

We meet Tuesdays and Thursdays 13:00-14:30 in Seigle L006. My office hours are Thursdays 14:30-16:00 in Seigle Hall 339. TA: Dongya Koh (dkoh[at]wustl.edu) Tue 15:00-16:30, and Wung Lik Ng (wlng@artsci.wustl.edu) Fri 10:30-12:00.

Course Description:

This is an intermediate course in Macroeconomics which focuses on understanding development processes, economic growth, aggregate fluctuations, and several dimensions of inequality. The object of interest in Macroeconomics is the entire economy: we will be particularly interested in some of the debates about the performance of the economy and in its associated policy questions. In this course we will take care of the aggregate economy building on solid microfoundations which means that i) we use models populated by agents (households, firms, and government) that optimize their own behavior, and ii) the implied equilibrium allocations that result from the behavior of agents satisfy aggregate consistency conditions (essentially market clearing). Understanding the concept of equilibrium will then be the single most important theoretical tool of the course. The prerequisites are Econ 104B, and Econ 4011. This course demands the degree of mathematical maturity associated with the concepts of sets, functions, derivatives, integrals, Taylor series, optimization, ordinary differential equations, and other material covered in Math 131.

Your feedback is extremely valuable and your suggestions on how to improve the course are very welcome. Remember that we are all in the same team and you can help improve the quality of the course by sharing your thoughts and suggestions---the higher the quality of the course the better for all of us.

We will use many parts of a textbook: 'Macroeconomics' by Stephen D. Williamson (2011), 4th edition. The book is available from the Wash U Bookstore and, I am sure, from many other places.

Grades and Requirements:

The requirements of the course are 4 equally valued quizzes and one final exam:

To compute your grade I will drop the quiz with the lowest score after normalization [Example]. This implies students must at least take three of the four quizzes. The quizzes are cumulative, that is, they include all the material that we have covered in class until the day of the quiz unless the course website specifies otherwise. Students will know their grade in a timely fashion. There will be no make-up quizzes.

The final letter grade distribution for the class will be as is standard in Economics Department courses.

Topics:

1. Introduction.
2. Growth and Development:
   • Stylized Growth and Development Facts.
   • Exogenous Growth Theory: The Malthus Model (Chapter 6 in W) and the Solow Model.
   • Endogenous Growth Theory: Human Capital, Externalities, and Economics of Ideas.
3. A One-Period Model of the Macroeconomy: Household Behavior, Firm Behavior, and Market Clearing (Chapter 4 and Chapter 5 in W).
4. A Two-Period Model: Intertemporal Substitution Effects and Credit Market Imperfections (Chapter 8 and Chapter 9 in W).
• Credit Frictions.
• Financial Crises.
5. A Model of Overlapping Generations (OLG) to understand Social Security: Intergenerational Effects (Chapter 9 in W).
6. An Intertemporal Model with Investment (Chapter 10 in W).
7. An Intertemporal Model with Money (Chapter 11 in W) [EXCLUDED FROM FINAL EXAM].
8. Aggregate Fluctuations:
   • Business Cycle Facts (Chapter 3 in W).
   • Business Cycle Theory: Sources and Propagation Mechanisms (Chapter 12 and 13 in W) [EXCLUDED FROM FINAL EXAM].
   • Unemployment: Search and Efficiency Wages (Chapter 17 in W).
9. Money, Inflation and Banking (Chapter 16 in W).
10. Inflation, the Phillips Curve and Central Bank Commitment (Chapter 18 in W) [EXCLUDED FROM FINAL EXAM].
11. Understanding Inequality: Data and Theory [EXCLUDED FROM FINAL EXAM].

Class Diary:

• Week 1
• Tue Jan 17th: The syllabus for this course is this site, and we discussed it in detail. We discussed the topics to be covered, and also went over the rules of the game in terms of requirements and grading.
• Thu Jan 19th: We discussed the Kaldor facts for modern industrialized economies for which there is evidence of balanced growth. Several development facts regarding cross-country heterogeneity in income levels, growth rates, take-off dates, etc. have been introduced. We have also discussed the nonstationarity of the process of economic development, and the implied shift in the production structure from agriculture to industry. We have also studied facts regarding the relationship between population and development, including the dependency ratio, life expectancy, and the properties of the demographic transition. We have continued discussing why correlates do not imply causation. To do so we have focused our dicussion on the correlation between economic growth with population growth, investment rates, and schooling. We also have agreed that without causation we cannot inform policy. We have finished the session with a brief discussion about other potential explanations for growth such as institutions, culture, geography, etc. Slides: [Economic Growth and Development Facts].
• Week 2
• Tue Jan 24th: We continued to explore growth coducting a growth accounting exercise. To do so we have introduced some mathematical tools that help us compute growth rates in discrete as well as in continous time. We have defined what an aggregate production function is, and derived the growth rate of ouput as the weighted sum of the growth rate of observable inputs plus the Solow residual. We went over the potential problems in doing growth accounting: mismeasurment of inputs, human capital adjustments, unobserved utilization of capital, etc. Output variables have also potential problems related to the measurement of home production, housing services, etc. Knowing these caveats, we have discussed TFP growth in the U.S. and explored some explanations for the productivity slowdown in the 1970s. In particular, we have discussed the role of the oil crisis and the beginnings of the IT revolution. We have also done cross-country growth accounting and analyzed the role of TFP growth for the Asian Tigers. Here you have an example of what the total factor productivity residual is, among many other things: the division of labor.
• Thu Jan 26th: We reviewed the concept of constant returns to scale (CRS) technologies [CRS Technologies] and started our discussion of the Malthus model. Slides, pages 6 to 30 here: [The Malthus Model, Chapter 6 in W].
• Week 3
• Tue Jan 31st: Class was cancelled.
• Thu Feb 2nd: We have finished our discussion on the Malthus model. We have discussed implications of several policies on the long-run standards of living in the context of this model. We have discussed the effects of agricultural technological improvements, the effects of family planning policies that restrict population growth, and the effects of disease and plagues. Does the Black Death increase the standards of living of the population? We have analyzed the sequence of events for each of these policies/shocks and described the dynamics over time for population growth, the population level, land per capita, and consumption per capita from an initial steady-state equilibrium to a new one (some times, an identical one).
• Week 4
• Tue Feb 7th: The Solow model begins. We are after a model that helps us understand the role of investment as determinant of economic growth. To do so we introduced all the primitives of the Solow model. This includes the neoclassical production function, a constant savings rate, and exogenous population dynamics. We then derived the fundamental growth equation in per capita terms. We defined the savings curve and the depreciation curve. Then we derived the steady-state equilibrium of this economy and discussed how we can map implications of this equilibrim concept to cross-sectional data. Slides: [The Solow Model]
• Thu Feb 9th: Quiz 1.
• Week 5
• Tue Feb 14th: We discussed the effects of some policies using the Solow model: increasing savings rates, and decreases in population growth. We introduced the golden rule associated to max consumption, and derived the savings rate that generates the golden rule. Then, we discussed the efficiency of the transitional dynamics to the golden rule, from below and from above.
• Thu Feb 16th: We posed the Solow model in growth rates, redefined the savings and depreciation curves, and derived again the steady-state equilibrium in the Solow model. We showed that the equilibrium exists, is unique, and stable. We started to discuss why growth is bounded: the law of diminishing returns or the Inada conditions? We discussed why policy does not generate changes in the steady-sate growth rate. In particular, we studied why increasing savings rates or decreasing population growth is not a long-run solution for poor economies. We introduced the role of technological progress. With exogenous technological progress the Solow model generates a positive long-run growth rate. We say this is an exogenous growth model because it generates growth in an environment where agents (and policy) cannot affect the long-run growth rate. We introduced the concept of speed of convergence in the Solow model. We discussed the absolute and conditional convergence hypothesis. We ended up our session with a simple human capital extension of the Solow model, the Mankiw-Romer-Weil model.
• Week 6
• Tue Feb 21st: We started our discussion on endogenous growth theory. Two properties derived from the neoclassical production function used in the Solow model are diminishing returns to capital, and the Inada conditions. We introduced a model that violates these two properties: the AK model. We discussed the implications of the AK model for the existence of long-run growth. Then we introduced the Romer model that also generates long-run growth through the presence of a positive externality, knowledge spillovers. In the Romer model long-run growth is attained under certain conditions on the size of the externality with respect to the size of labor share. Slides: [Endogenous Growth Models]
• Thu Feb 23rd: We went back to our growth facts to discuss a dual approach that uses factor prices instead of factor quantities to do growth accounting (Hsieh ,1998). We discussed how to relate the theoretical implications of the speed of convergence in the Solow model to the data. We have then discussed the implications of human capital for the speed of convergence (Mankiw, Romer, and Weil, 1992). We also opened the Solow economy. We continued our discussion on endogenous growth. We reviewed the Romer model with an externality on capital per capita. Then, we discussed the scale effects implied by considering that the externality is on aggregate capital.
• Week 7
• Tue Feb 28th: We discussed the two-sector human capital Lucas-Uzawa model and its relationship to the AK model. Then using the Jones and Manuelli technology we saw that the key to growth is the violation of the Inada conditions. We discussed the presence of poverty traps.
• Thu March 1st: Quiz 2.
• Week 8
• Tue March 6th: We went over optimal consumer behavior and derived the optimatility conditions of maximization of utility subject to a budget constraint. We discussed in detail income and substitution effects that arise from changes in the wage rate and nonlabor income. We derived the aggregate labor supply and the assumptions that underly its upward-looking property. Slides: [Consumer and Firm Behavior, Chapter 4 in W].
• Thu March 8th: We reviewed optimal firm behavior. We derived the optimility conditions of maximization of profit subject to technology. We derived aggregate labor demand.
• Week 9
• Thu March 20th: We set up a one-period macroeconomic model that builds on the interaction of optimal consumers and firms. We introduced government to explore fiscal policy. We defined the competitive equilibrium (C.E.), and concepts of market clearing and aggregate consistency. We derived the pareto optimal equilibrium (P.O.) as a maximization problem of a benevolent social planner subject to the aggregate resource constraint. Then, we established, mathematically, and in the context of our simple model example, the equivalence between C.E. and P.O.; we discussed the first and second welfare theorems. Slides: [One-Period Macro Model, Chapter 5 in W].
• Thu March 22nd: We discussed the general equilibrium effects of increasing government expenditures. We used our model to analyze the effects of government spending in WWII and in the American Recovery and Reinvestment Act of 2009. Then, we went over the macroeconomic effects of increases in total factor productivity; this implied reviewing the concepts of substitution and income effects. We discussed the suitability of Government spending and TFP changes to explain the long- and short-run behavior of the U.S. economy. We started our discussion on labor income taxation.
• Week 10
• Tue March 27th: We finished our discussion on taxation. We discussed how the Laffer curve arises as an equilibrium object of our model, in particular, we have discussed how the relationship of revenues and wage income tax rates depends on the endogenous effect of taxes on labor supply. We went in detail over the effects of a decrease in income taxes on both sides of the Laffer curve. We discussed whether we are in the good side or the bad side of the Laffer curve by looking at federal personal taxes as a percentage of GDP after the tax-cut polices implemented in 1981 and 2001. In our discussion we introduced the concept of "Voodoo economics", coined by George H.W. Bush in 1980 to refer to President Reagan's tax cuts: Ferris Bueller's Day off (1986). Finally, we introduced a 2-period model. Slides: [Two-Period Macro Model, Chapter 8 in W].
• Thu March 29th: Quiz 3.
• Week 11
• Tue April 3rd: We derived the intertemporal optimality condition. We defined lenders and borrowers. We discussed consumption smoothing. We studied the effects on current and future consumption of an increase in (a) current income (a transitory change in come), (b) future income, and (c) current and future income (a permanent change in income). We discussed the permanent income hypothesis and studied the effects of stock prices on consumption of nondurables and services. We analyzed the effects of an increase in the real interest rate on current and future consumption: substitution and income effects. While the substitution effect is identical for borrowers and lenders, the income effect depends on the sign of individual savings. We introduced a government with an intertemporal budget constraint to study the role of deficits. We defined the competitive equilibrium with an additional credit market equilibrium condition, total private savings is equal to government bonds.
• Thu April 5th: We will discuss Ricardian equivalence. We will go over credit market imperfections where lendres can lend at a lower interest rate than the one faced by borrowers. We will discuss the effects of a tax cut with credit market imperfections. Slides: [Credit Market Imperfections: Credit Frictions, Financial Crises, and Social Security, Chapter 9 in W].
• Week 12
• Tue April 10th: We discussed the financial aspects of the Great Recession. We have studied two types of credit market imperfections. First, we augmented our 2-period model with banks and discussed the presence of asymmetric information between banks and (good and bad) borrowers under the case where borrowers that have low income in the future decide to default on loans. We studied how the fact that banks do not know the type of borrowers (i.e., their risk of default) generates a default premium that makes the borrowing interest rate larger than the lending interest rate. Second we studied how banks try to prevent default (limited commitment) by using collateral constraints. We studied the implications of reductions in housing prices on household consumption allocations.
• Thu April 12th: We discussed the pay-as-you go social security system in the context of an overlapping generations model. We have seen that whether this system is welfare improving or not depends on the relationship between the population growth rate and the interest rate because the implicit return of the social security contract is precisely the population growth rate. We dicussed solutions to the retirement of the babyboom generation. We also discussed the fully-funded social security with mandatory savings. We went over business cycle facts including the volatility, co-movement with output, and persistence of the main aggregate economic variables. Slides: [Business Cycle Measurement, Chapter 3 in W] and [More on Business Cycle Measurement].
• Week 13
• Tue April 17th: We discussed a real intertemporal model with investment introducing an investment decision in the problem of firms in the context of a two period model. We also introduced the intertemporal labor supply, that is, we endogeneized current and future labor income. Using this model we discussed the general equilibrium effects of changes in government spending. Slides: [Investment Theory, Chapter 10 in W]. Optional material on business cycle theory [EXCLUDED FROM FINAL EXAM]: [Real Business Cycle Theory, Chapter 12 in W] and [Neo-Keynesian Business Cycle Theory, Chapter 13 in W]
• Thu April 19th: Quiz 4.
• Week 14
• Tue April 24th: We finished our discussion on the general equilibrium effects of TFP and aggregate capital shocks. We discussed the behavior of the unemployment rate in the U.S. We also discussed labor force participation, and female labor force participation. We introduced a labor search and matching model to study the decision of whether to work or not. We started our analysis of the efficiency wages model. Slides: [Labor Search and Efficiency Wages, Chapter 17 in W]. A closer look to the U.S facts on [unemployment and labor force participation by sex and age].
• Thu April 26th: Don finished our discussion on the efficiency wages model and introduced the Diamond-Dybvig model of bank runs, Slides: [Diamond Dybvig Model, Chapter 16 in W].

Quizzes and Solutions

• [Quiz 1] [Solution to Quiz 1] [Normalized Scores] [Histogram]
• [Quiz 2] [Solution to Quiz 2] [Normalized Scores] [Histogram]
• [Quiz 3] [Solution to Quiz 3] [Normalized Scores] [Histogram]
• [Quiz 4] [Solution to Quiz 4] [Normalized Scores] [Histogram]
• Practice [questions] and [their solutions] Topics: One-Period Macro Model, Two-Periods Macro Model, Credit Market Imperfections, Labor Search, Efficiency Wages, etc.
• [Final Exam] [Solution to Final Exam] [Normalized Scores] [Histogram]

Previous Exams and Quizzes

• Spring 2011
• Fall 2009
• Fall 2008