Macroeconomic Theory II

Readings

There are no textbooks for the course. Material will come from several sources. Readings by session are given below.

Recommended Texts

Covers most bases, but is aging:

[BF] Blanchard, O., and S. Fischer. Lectures on Macroeconomics. Cambridge, MA: MIT Press, 1989. ISBN: 9780262022835.

Focuses more on open economy issues:

[OR] Obstfeld, M., and K. Rogoff. Foundations of International Macroeconomics. Cambridge, MA: MIT Press, 1996. ISBN: 9780262150477.

Focuses more on nominal rigidities, and the role of monetary policy:

[MW] Woodford, M. Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, NJ: Princeton University Press, 2003. ISBN: 9780691010496.

Macroeconomics is a rapidly changing field. To get a sense of the geography, you might find it useful to read two surveys (which are already on the verge of obsolescence…):

Blanchard, O. “What Do We Know About Macroeconomics that Fisher and Wicksell Did Not?” Quarterly Journal of Economics 115, no. 4 (November 2000): 1375-1410.

Woodford, M. “Revolution and Evolution in Twentieth-Century Macroeconomics.” Paper presented at Frontiers of the Mind in the Twenty-First Century, U.S. Library of Congress, Washington, DC, June 1999.

For two more recent and more polemical, pieces, you may also want to read:

Chari, V. V. “Modern Macroeconomics in Practice: How Theory is Shaping Policy.” Journal of Economic Perspectives 20, no. 4 (2006): 3-28.

Mankiw, N. G. “The Macroeconomist as Scientist and Engineer.” Journal of Economic Perspectives 20, no. 4 (2006): 29-46.

Readings by Session

TOPIC #	TOPICS	READINGS
1	Fluctuations facts Covariance stationarity Trends/cycles decompositions Shocks and propagation mechanisms Wold representation ARMAs, VARs, SVARS Impulse responses Co-movements of GDP components Correlations between real wages, interest rates, and output The correlations of output and money Cycles, slumps, and depressions Nonlinearities	Required readings BF, chapter 1. Stock, J., and M. Watson. “Business Cycle Fluctuations in U.S. Macroeconomic Time Series.” Chapter 1 in Handbook of Macroeconomics. Vol 1A. Edited by J. Taylor and M. Woodford. New York, NY: Elsevier, 1999. ISBN: 9780444501561. Additional readings A nice refresher on time series and VARs: Cochrane, J. “Time Series for Macroeconomics and Finance.” mimeo University of Chicago, 2005, pp. 1-65. Blanchard, O., and D. Quah. “The Dynamic Effects of Aggregate Demand and Aggregate Supply Disturbances.’’ American Economic Review 79, no. 4 (1989): 654-673. Christiano, L., M. Eichenbaum, and C. Evans. “Monetary Policy Shocks: What have we Learned and to What End?” Handbook of Macroeconomics. Vol. 1A. Edited by J. Taylor and M. Woodford. New York, NY: Elsevier, 1999, pp. 65-148. ISBN: 9780444501561. Aguiar, M., and G. Gopinath. “Emerging Market Business Cycles,” and “The Cycle is the Trend.” Journal of Political Economy 115, no. 1 (2007): 69-102.
2	The basic model: The consumption/saving choice Setting up the optimization problem Intertemporal choice, shocks, uncertainty The first order conditions The Keynes-Ramsey condition Solving the model numerically Value functions Log linearization Special cases and other short cuts Equivalence between centralized and decentralized economies The consumption problem in the decentralized economy	Required readings BF, chapter 2 and section 6-2. Additional readings OR, chapters 1 and 2. Campbell, J. “Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model.” Journal of Monetary Economics 33, no. 3 (June 1994): 463-506. Uhlig, H. “A Toolkit for Analyzing Nonlinear Dynamic Stochastic Models Easily.” mimeo University of Tilburg, 1997. (PDF)
3	Allowing for labor/leisure choice (the RBC model) Movements in employment/unemployment Interpreting the first order conditions Solving the model numerically, and by log linearization Special case: log and full depreciation Evidence on labor supply elasticity Evidence on high frequency technological shocks Solow residuals and their interpretation Alternative approaches	Required readings BF, chapter 7. King, R., and S. Rebelo. “Resuscitating Real Business Cycles.” Chapter 14 in Handbook of Macroeconomics. Vol. 1B. Edited by J. Taylor and M. Woodford. New York, NY: Elsevier, 1999, pp. 927-1007. ISBN: 9780444501578. Additional readings Prescott, E. C. “Theory Ahead of Business Cycle Measurement.” Federal Reserve Bank of Minneapolis Quarterly Review 10, no. 4 (Fall 1986): 9-22. Rebelo, S. “Real Business Cycle Models: Past, Present and Future.” National Bureau of Economic Research Working Paper No. 11401, June 2005. Gali, J., and P. Rabanal. “Technology Shocks and Aggregate Fluctuations: How Well does the RBC Model Fit Postwar U.S. Data?” In NBER Macroeconomics Annual 2004. Edited by M. Gertler and K. Rogoff. Cambridge, MA: MIT Press, pp. 225-318. ISBN: 9780262572293. Basu, S., J. Fernald., and M. Kimball. “Are Technology Improvements Contractionary?” Federal Reserve Bank of Chicago, WP-2004-20. Aghion, P., and P. Howitt. “Growth and Cycles.” Chapter 8 in Endogenous Growth Theory. Cambridge, MA: MIT Press, 1998. ISBN: 9780262011662. Shleifer, A. “Implementation Cycles.” Journal of Political Economy 94, no. 6 (December 1986): 1163-1190.
4	Allowing for non-trivial investment decisions Costs of adjustment for investment Investment, consumption, and interest rates in the decentralized economy The role of the term structure of interest rates The stock market and investment The effects of shocks on output, investment, the stock market, and the term structure The open economy version Shocks, investment, saving, and movements in the current account Asset price bubbles, investment, and fluctuations	Required readings BF, sections 2-4 and 6-3. BF, sections 5-1 and 5-2. Additional readings OR, chapter 3. Shiller, R. Irrational Exuberance. Princeton, NJ: Princeton University Press, 2000. ISBN: 9780691050621. Blanchard, O., C. Rhee, and L. Summers. “The Stock Market, Profit, and Investment.” Quarterly Journal of Economics 108, no. 1 (February 1993): 115-136.
5	Allowing for two goods Why introduce two goods? The pitfalls of one-good models Capital/consumption goods Tradable/non tradable goods Domestic/foreign goods The consumer problem with two goods Intratemporal and intertemporal first order conditions Closing the model if tradables/non tradables The Balassa-Samuelson effect The transfer problem Effects of technological shocks on relative prices, and on the current account Global imbalances	Required readings Obstfeld, M., and K. Rogoff. “The Intertemporal Approach to the Current Account.” Chapter 34 in Handbook of International Economics. Vol. 3. Edited by G. Grossman and K. Rogoff. New York, NY: Elsevier, 1997, pp. 1731-1799. ISBN: 9780444828644. Additional readings OR, chapter 4. Blanchard, O. “Current Account Deficits in Rich Countries.” mimeo MIT Department of Economics Working Paper No. 07-06, February 2007.
6	Introducing money Decentralized exchange and the use of money Cash-in-advance models Money in the utility function The effects of money growth on capital accumulation Dynamics of hyperinflation The Cagan model The budget deficit and money growth	Required readings BF, sections 4.3-4.7 and 10.2. Additional readings MW, chapter 2-1, and “Price Level Determination under Interest Rate Rules.” Dornbusch, R., F. Sturzenegger, H. Wolf, S. Fischer, and R. Barro. “Extreme Inflation: Dynamics and Stabilization.” Brookings Papers on Economic Activity 1990, no. 2 (1990): 1-84.
7	Introducing price setting Decentralized exchange, money, and price setters A yeoman farmer model of price setting under monopolistic competition The role of price above marginal cost, markups Predetermined prices The effects of money on output and welfare Role of wage versus price setting The behavior of real wages Revisiting the effects of technological and other shocks Indexation Macroimplications of the choice of numeraire The monetary policy problem Time consistency	Required readings Blanchard, O. “Why Does Money Affect Output? A Survey.” In Handbook of Monetary Economics. Vol 2. Edited by B. Friedman and F. Hahn. New York, NY: Elsevier, 1990, pp. 779-835. ISBN: 9780444880260. BF, sections 8-1 and 11-4. MW, chapter 3-1, and “Optimizing Models with Nominal Rigidities. A Basic Sticky-Price Model.” Additional readings Dhyne, E., L. Álvarez, H. Le Bihan, G. Veronese, D. Dias, J. Hoffmann, N. Jonker, P. Lünnemann, F. Rumler, and J. Vilmunen. “Price Changes in the Euro area and the United States: Some Facts from Individual Consumer Price Data.” The Journal of Economic Perspectives 20, no. 2 (2006): 171-192.
8	The “new Keynesian” model Staggering of price decisions Fischer-Taylor-Calvo models Coordination problems The “modern Phillips curve” Inflation inertia? The “modern IS-LM model,” and the “modern AS-AD model” A second look at productivity booms	Required readings BF, chapters 8-2 and 8-3. Additional readings MW, chapter 3-2, “Optimizing Models with Nominal Rigidities,” and “Inflation Dynamics with Staggered Price Setting.” King, R. “The New IS-LM model: Language, Logic, and Limits.” Federal Reserve Bank of Richmond Economic Quarterly 86, no. 3 (Summer 2000): 45-103.  Blanchard, O., and J. Gali. “Real Wage Rigidities and the New Keynesian Model.” mimeo MIT, February 2006. Beaudry, P., and F. Portier. “Stock Prices, News, and Economic Fluctuations.” mimeo University of British Columbia, March 2004. (PDF) Lorenzoni, G. “A Theory of Demand Shocks.” mimeo MIT, November 2006. Smets, F., and R. Wouters. “Comparing Shocks and Frictions in US and Euro Area Business Cycles: A Bayesian DSGE Approach.” Center for Economic Policy Research Discussion Paper No. 4750 (November 2004): 1-26.
9	Monetary policy Time consistency Inflation targeting Interest rate rules The liquidity trap	Required readings Clarida, R., J. Gali, and M. Gertler. “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature 37 (December 1999): 1661-1707. Additional readings MW, chapters 4-1 and 4-2, and “A Neo-Wicksellian Framework for the Analysis of Monetary Policy.” Gali, J. “New Perspectives on Monetary Policy, Inflation, and the Business Cycle.” National Bureau of Economic Research Working Paper No. 8767, February 2002: 1-52. King, M. “What has Inflation Targeting Achieved?” In The Inflation-Targeting Debate. Edited by B. Bernanke and M. Woodford. Chicago, IL: University of Chicago Press, 2005. ISBN: 9780226044712. Bernanke, B., V. Reinhart, and B. Sack. “Monetary Policy Alternatives at the Zero Bound. An empirical assessment.” Finance and Economics Discussion Series 2004-48. Washington, DC: Divisions of Research and Statistics and Monetary Affairs, Federal Reserve Board, 2004. (PDF) Svensson, L. “Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others.” National Bureau of Economic Research Working Paper No. 10195 (December 2003): 1-24.
10	Fiscal policy Effects of spending and taxes in models with flexible or sticky prices Empirical evidence Perverse effects of fiscal expansions	Required readings Galí, J., J. López-Salido, and J. Vallés. “Understanding the Effects of Government Spending on Consumption.” Journal of the European Economic Association 5, no. 1 (March 2007): 227-270. Additional readings Chari, V. V., and P. Kehoe. “Optimal Fiscal and Monetary Policy.” Federal Reserve Bank of Minneapolis Staff Report 251 (July 1998). Baxter, M., and R. King. “Fiscal Policy in General Equilibrium.” American Economic Review 83, no. 3 (June 1993): 315-334. Blanchard, O., and R. Perotti. “An Empirical Characterization of the Dynamic Effects of Government Spending and Taxes on Output.” Quarterly Journal of Economics 117, no. 4 (2002): 1329-1368. Giavazzi, F., and M. Pagano. “Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience.” National Bureau of Economic Research Working Paper No. 5332 (October 1996): 1-50.