Syllabus for Econ 502
Masters-Level Macroeconomic Theory

Syllabus Last Updated: 20 November 2009 Latest Course Offering: Fall 2009 Course Instructor: Professor Leigh Tesfatsion Department of Economics Iowa State University Ames, Iowa 50011-1070 (515) 294-7318 (Secretary) http://www.econ.iastate.edu/tesfatsi/ tesfatsi AT iastate.edu 502 Homepage (Course Structure & Grading Policy) In-Class Discussion Schedule (To Be Announced) General Macro/Financial Resources

Course Meeting Time and Place: TR 11-1, 272 Heady F 12:10-1, 272 Heady Instructor's Office and Office Hours: Office: 375 Heady Hall Hours: Fridays 10-12 and by appointment. Teaching Assistant (TA): Ms. Miyoung Oh Tel: 294-5452 my153 AT iastate.edu TA's Office and Office Hours: Office: Heady 75 Hours: Wed 10-11am, 3-4pm and by appointment.

Syllabus Contents:

• Required Course Materials (for Purchase)

• Basic Recommended Source Materials (On-Line, Library)

• Topics, Discussion Questions, and Readings
  1. Introduction
     1. Course Overview
     2. Empirical Characteristics of the U.S. Economy
     3. Macro Modeling: Alternative Approaches
  2. Aggregate Macroeconomic Modeling: A Microfoundations Critique
     1. The Basic IS-LM Model
     2. Aggregate Supply and Price Adjustment
     3. Critiques of Aggregate Macroeconomic Modeling: Summary Overview
  3. Economic Growth: A Microfoundations Approach
     1. Growth Overview
     2. Basic Economic Growth Modeling Concepts
     3. Basic Solow-Swan Descriptive Growth Model
     4. Basic Optimal Growth Model
     5. Basic Overlapping Generations Model
  4. Treatment of Expectations in Macroeconomic Models
     1. Rational vs. Adaptive Expectations
     2. Implications for Policy Choice Over Time
  5. Dynamic Stochastic General Equilibrium Models and Taylor Rules
     1. Recent Developments in DSGE Modeling
     2. Taylor Rules and Central Bank Monetary Policy
  6. Permitting Endogenous Coordination in Macroeconomic Models
     1. Post-Walrasian Macroeconomics
     2. A Constructive Approach to Macroeconomic Coordination
     3. Illustration of Constructive Macro Modeling: Labor Institutions and Macro Performance

• Midterm and Final Exam Review Materials

Required Course Materials (for Purchase)

• Required Course Packet:
  

  Class Lecture Notes for Economics 502: Fall 2009, a packet of lecture materials (401 pages) prepared by the instructor. Shrink-wrapped three-hole-punched copies of this packet are available for purchase from Copyworks (105 Welch Avenue, Ames, 292-3630) for a price of $15.75. A discount coupon for a three-ringed notebook should be included with each packet. Copyworks is typically open 24 hours each day of the week.

  NOTE: If packet copies are sold out, alert Copyworks and additional copies will be made on a short turn-around basis.

Basic Recommended Source Materials (On-Line, Library)

• Online Resources:

  • General Resources for Macro and Financial Economics (html) (L. Tesfatsion, ISU). This website provides an annotated list of pointers to a variety of online materials focusing on macro policy, macro theory, and empirical macro data. Students can browse this site for additional materials related to in-class discussion questions of interest.

  • Economic Growth Resources (html) (Jonathan Temple, U of Bristol, UK). Resources included at this website include surveys, references, researchers, papers, data sets, journals, events, networks, and related links.

  • Learning and the Embodied Mind (html) (L. Tesfatsion, ISU). This website provides annotated pointers to research on learning representations for strategically-interacting economic agents as well as general research on behavioral economics motivated by human-subject experiments.

  • Learning and Coordination in Decentralized Market Economies (html) (L. Tesfatsion, ISU). Resources provided at this website include tutorials, surveys, readings, websites, demonstration software, software toolkits, and pointers to individual researchers and research groups taking an agent-based modeling approach to learning and coordination in decentralized market economies.

• Volumes Containing Recommended Readings:

  • Philippe Aghion and Steven N. Durlauf (Eds.), Handbook of Economic Growth, Volume 1A, Elsevier B.V., 2005.
  • Robert Barro and X. Sala-i-Martin, Economic Growth, McGraw-Hill, Inc., Latest Edition.
  • David Colander (ed.), Post-Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006.
  • David Colander (ed.), Beyond Microfoundations: Post Walrasian Macroeconomics, Cambridge U Press, Cambridge, MA, 1996.
  • Kevin Hoover, The New Classical Macroeconomics: A Skeptical Inquiry, Basil Blackwell, Cambridge, MA, 1990 (paperback,ISBN:0-631-17263-7).

    Note: The original hardcover version of the Hoover book was published in 1988. The first paperback edition was published in 1990 and subsequently reprinted in 1991 and 1992.

  • Peter Howitt, The Keynesian Recovery and Other Essays, The U of Michigan Press, Ann Arbor, MI, 1990.
  • John M. Keynes, The General Theory of Employment, Interest, and Money, Macmillan, 1936, reprinted edition.
  • David Romer, Advanced Macroeconomics, McGraw-Hill, Latest Edition.
  • Thomas J. Sargent, Bounded Rationality in Macroeconomics, Oxford U Press, 1993.
  • Steven M. Sheffrin, The Making of Economic Policy: History, Theory, and Politics, Basil Blackwell, Cambridge, MA, 1991 (paperback, ISBN:1-55786-294-X).
  • John B. Taylor and Michael Woodford (Eds.), Handbook of Macroeconomics, Handbooks in Economics Series, North-Holland, Amsterdam, 1999 (3-Volume Set).

• Intermediate Macro Texts Recommended for Background Review:

  • 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 may be useful for answering exam questions and exercises.

All readings with double and single asterisks are listed in a suggested reading order. Each of these readings can be obtained either in the required course packet, as a class hand-out, on-line, or in the Parks Library. 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

1. COURSE OVERVIEW

   Key Questions for In-Class Discussion:

   • What is "macroeconomics"?
   • What lessons should be drawn from the current economic and financial crisis for the study of macroeconomics?
   • What are some of the key approaches macroeconomists have been taking to the theoretical study of macroeconomic systems over the past forty years? Are these approaches now discredited? In need of major revision? Still viable?
   • What issues will this course address?

   Required Readings:

   • [**] L. Tesfatsion, "What is Macroeconomics All About?". PACKET

   • [**] Editorial and accompanying opinion pieces, "What Went Wrong with Economics?", "The Other Worldly Philosophers", and "Efficiency and Beyond" (pdf,323K), The Economist, July 16th, 2009. ON-LINE

   **Important Note:**

   The following five perspectives by well-known economists present five distinctly different views regarding the development of macroeconomics since the publication of Keynes' General Theory of Employment, Interest, and Money in 1936. At this point all that is required is that you skim the articles to get a general sense of what is claimed. More careful readings of these articles should then 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, 119K), presented at the conference Frontier of the Mind in the Twenty-First Century, Library of Congress, Washington, D.C., June 1999. ON-LINE

   [**] N. Gregory Mankiw, "The Macroeconomist as Scientist and Engineer" (pdf,102K), Journal of Economic Perspectives, Vol. 20, No. 4, Fall 2006, 29-46. ON-LINE

   Note: See, also, Mankiw's blog page for economics students.

   [**] Edmund S. Phelps, "Macroeconomics for a Modern Economy" (pdf,128K), Nobel prize lecture, Stockholm, Sweden, December 10, 2006. ON-LINE

   [**] David Colander, "Introduction", emphasis on pp. 1-16, in David Colander (ed.), Post Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006. HAND-OUT

   [**] Axel Leijonhufvud, "Episodes in a Century of Macroeconomics", pp. 27-45 in David Colander (ed.), Post Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006. HAND-OUT

   Note: For an on-line study that covers some of the same ground, see Leijonhufvud's article "Agent-Based Macroeconomics" (pdf,93K), 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. ON-LINE

   Other Suggested Readings and Websites

   

2. EMPIRICAL CHARACTERISTICS OF THE U.S. ECONOMY

   Key Questions for In-Class Discussion:

   • Historical facts about the U.S. economy
   • How is the U.S. economy weathering the current crisis?
   • Empirical comparisons with other economies

   ** Take-Home Exercise 1: Construction of Macroeconomic States (pdf,28K). Due: Tuesday, September 1, 11:00am (beginning of class).

   Required Readings:

   • [**] L. Tesfatsion, "Key U.S. Historical Benchmarks". PACKET

   • [**] L. Tesfatsion, "Empirical Data for the United States". HAND-OUT

   Recommended Readings:

   • [ *] 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. ON-LINE

   • [ *] The Economagic Economic Time Series Page maintained by Economagic Inc. provides access to an extensive variety of economic time series (primarily U.S. data) with customized graphing and printing facilities. ON-LINE

   • [ *] The Gapminder site "unveils the beauty of statistical time series by converting boring numbers into enjoyable, animated and interactive graphics." The site focuses on comparative time series data for economic, social, and environmental development at local, national, and global levels.

   • [ *] Abel and 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

   

3. MACRO MODELING: ALTERNATIVE APPROACHES

   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?

   ** Take-Home Exercise 2: Modeling with Simultaneous Equations (pdf,28K). Due: Friday, September 11, 12:10 (beginning of class).

   Required Readings:

   • [**] L. Tesfatsion, "In-Class Consulting Exercise". HAND-OUT

   • [**] L. Tesfatsion, "Universal Economic Principles?". PACKET

   • [**] L. Tesfatsion, "Introduction to Walrasian General Equilibrium Modeling (pdf,67K). PACKET
     Note: As will be seen throughout the remainder of the course, the WGE model is the principal paradigm underlying current mainstream macroeconomic theory.

   Recommended Reading:

   • Christopher D. Mackie, Canonizing Economic Theory: How Theories and Ideas are Selected in Economics, M. E. Sharpe, Inc., 1998.

   Other Suggested Readings and Websites

II. AGGREGATE MACROECONOMIC MODELING: A MICROFOUNDATIONS CRITIQUE

1. THE BASIC IS-LM MODEL

   Key Questions for In-Class Discussion:

   • What are the strengths and weaknesses of the basic IS-LM model?
   • Why does the basic IS-LM model 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 3: Short-Run Effects of Deficit Increases. Due: Friday, September 18, 12:10 (beginning of class).

   Required Readings:

   • [**] L. Tesfatsion, "The Economy as a Circular Flow". PACKET

   • [**] L. Tesfatsion, "The Basic Short-Run IS-LM Model with Sticky Prices". PACKET
     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:

   • [ *] 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).

   • [ *] Keynes, op. cit., Chapters 1-3, 8-15, and 18.
     Supposed source of the IS-LM model -- see for yourselves.

   Other Suggested Readings and Websites

   

2. AGGREGATE SUPPLY AND PRICE ADJUSTMENT

   Key Questions for In-Class Discussion:

   • How can the basic single-period IS-LM model be augmented with dynamic relationships (e.g., an expectations augmented Phillips curve) to permit 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 4: Dynamic Effects of Deficit Increases in a Sticky-Price Model. Due: Friday, September 25, 12:10 (beginning of class).

   [** ] Take-Home Exercise 5: Dynamic Effects of Deficit Increases in a Flexible-Price Model. Due: Friday, October 2, 12:10 (beginning of class).

   Required Readings:

   • [**] L. Tesfatsion, "Aggregate Supply and Price Adjustment: The Dynamic Sticky-Price IS-LM Model". PACKET
     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". PACKET

     [**] L. Tesfatsion, "The Dynamic Sticky-Price IS-LM Model: An Illustrative Exercise". PACKET

     [**] L. Tesfatsion, "Adaptive versus Rational Expectations". PACKET

     [**] L. Tesfatsion, "A Dynamic Flexible-Price IS-LM Model with Rational Expectations". PACKET

     [**] L. Tesfatsion, "Policy Experiments with Two Versions of the Dynamic IS-LM Model: Sticky-Price Vs. Flexible Price". PACKET

     [**] L. Tesfatsion, "Definitions of Various Conceptions of Money Neutrality in Macro". PACKET

   Recommended Readings:

   • [ *] Hall and Taylor, op. cit., chapters titled "The Adjustment Process" and "Macroeconomic Policy".
     Note:These Part-3 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.

     [ *] Abel and Bernanke, op. cit., Part-4 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.

     [ *] K. Hoover, Chapter 2 ("Clearing Labor Markets"), in The New Classical Macroeconomics, op. cit., pp. 23-37.

     Note: Hoover discusses the Phillips curve and the natural rate hypothesis. He also discusses the neutrality (ineffectiveness) of monetary policy when rational expectations is combined with a "Lucas-Rapping supply curve," as in the flexible-price dynamic IS-LM model with rational expectations. (More advanced discussion than Abel/Bernanke and Hall/Taylor).

     [ *] 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: R. Solow, J. Taylor, M. Eichenbaum, A. Blinder, and O. Blanchard. This should be interesting to (re)read from the vantage point of the 2007-2009 economic crisis!

   Other Suggested Readings and Websites

   

3. CRITIQUES OF AGGREGATE MACROECONOMIC MODELING: SUMMARY OVERVIEW

   Key Questions for In-Class Discussion:

   • Microfoundations Issues
   • Expectations Modeling Issues
   • Coordination Issues

   Required Reading:

   • [**] L. Tesfatsion, A Simple Dynamic IS-LM Model with Bond and Wealth Effects. PACKET
     Note: This packet reading develops a simple flexible-price IS-LM model that explicitly incorporates the possible effects of wealth on household saving and consumption decisions. It is seen that this incorporation of wealth effects requires at least five significant changes in the "microfoundations" underlying the standard IS-LM model in order to obtain a logically consistent stock-flow model satisfying basic accounting identities. The necessity of these changes highlights a number of substantial problems with the standard IS-LM model.

III. ECONOMIC GROWTH: A MICROFOUNDATIONS APPROACH

1. GROWTH 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 are many economists in agreement that a theoretical framework is needed to think seriously about economic growth?
   • What kinds of theoretical frameworks might be used?
   • What should the scope of these theoretical frameworks be, e.g., can economic growth be satisfactorily explained purely in terms of economic factors?
   • What does empirical evidence suggest are the primary determinants of economic growth?
   • 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?

   Required Reading:

   • [**] Jonathan Temple, "The New Growth Evidence", Journal of Economic Literature, Vol. XXXVII (March 1999), 112-156, stress on Sections 6-10 (pp. 133-156). HAND-OUT
     Note: The focus of this excellent detailed survey paper is predominantly on cross-country empirical growth research. Six issues are examined: the evolution of the world income distribution; the possible convergence to steady-state growth paths; diminishing returns to inputs; the determinants of wealth; divergencies in growth rates; and the prospects for growth in the longer run. Subtleties in measuring output levels and growth rates are also taken up.

   Recommended Readings:

   • [ *] Robert Solow, Reflections on Growth Theory (pdf,44K), pp. 3-10 in P. Aghion and S. N. Durlauf (Eds.), Handbook of Economic Growth, Volume 1A, Elsevier B.V., 2005. ON-LINE
     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 demandside and supply-side variations)."

     [ *] Leigh Tesfation, "Notes on the Existence of Aggregate Production Functions" (pdf,61K). ON-LINE

     Abstract: These notes summarize the stringent necessary conditions determined by Franklin Fisher for the existence of an aggregate production function of the form Y = F(K,L) as standardly used in growth models based on the Solow-Swan growth model, the Ramsey optimal growth model, or the overlapping generations model.

     [ *] Jonathan Temple, "Aggregate Production Functions and Growth Economics" (pdf,267K), International Review of Applied Economics 20(1), July 2006, 301-317. ON-LINE

     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.

     [ *] Dani Rodrik, Growth Strategies (pdf,1M), Chapter 14 (pp. 967-1014) in P. Aghion and S. N. Durlauf (Eds.), Handbook of Economic Growth, Volume 1A, Elsevier B.V., 2005. ON-LINE

     Abstract: "This is an attempt to derive broad, strategic lessons from the diverse experience with economic growth in last fifty years. The paper revolves around two key arguments. One is that neoclassical economic analysis is a lot more flexible than its practitioners in the policy domain have generally given it credit. In particular, first-order economic principles – protection of property rights, market-based competition, appropriate incentives, sound money, and so on – do not map into unique policy packages. Reformers have substantial room for creatively packaging these principles into institutional designs that are sensitive to local opportunities and constraints."

     The Economic Growth Resources Website maintained by Jonathan Temple (U of Bristol, UK). Resources included at this site include surveys, references, researchers, papers, data sets, journals, events, networks, and related links. ON-LINE

     The Growth Theory Website maintained by the Schwartz Center for Economic Policy Analysis (CEPA) at the New School for Social Research, New York. ON-LINE

   Other Suggested Readings and Websites

   

2. BASIC ECONOMIC GROWTH MODELING CONCEPTS

   Key Questions for In-Class Discussion:

   • Some essential facts about systems of ordinary differential/difference equations (ODEs)
   • Macrodynamic models in state-space ODE form - general structural considerations
     • Three-way classification of variables
     • Definition of a model solution
     • Definition and derivation of the "basic causal differential system"

   [** ] First In-Class Student-Moderated Discussion: "Wither Macroeconomics? Implications of the Global Financial Crisis for Macroeconomics as a Science" (pdf,27K). Scheduled for: October 20, 2009, 11-12:20pm.

   Required Readings:

   • [**] L. Tesfatsion, "Notes on Differential Equations". PACKET

   • [**] L. Tesfatsion, "Macrodynamic Models in Equation Form: General Structural Considerations". PACKET

   Recommended Readings:

   • [ *] Barro and 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.

     [ *] Russell Cooper, "Dynamic Programming: An Overview" (pdf,19pp) February 14, 2001. ON-LINE

     Note: This overview provides a clear basic introduction to dynamic programming, illustrated by economic examples. It is highly recommended for students planning to pursue a Ph.D. in economics.

     [ *] Gianluca Violante, "Notes on Discrete Time Stochastic Dynamic Programming" (pdf,14pp), Spring 2000. ON-LINE

     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.

   

3. BASIC SOLOW-SWAN DESCRIPTIVE GROWTH MODEL

   Key Questions for In-Class Discussion:

   • What are the basic issues the one-sector Solow-Swan descriptive growth model (SSM) is meant to address?
   • How does the SSM compare and contrast with the Walrasian general equilibrium model?
   • How does the SSM compare and contrast with the (flexible/sticky-price) dynamic IS-LM Model?
   • What are the basic predictions of the SSM regarding short-run and long-run growth rates of economies?
   • How has the SSM been extended to include technological change? factor markets?
   • Are the properties of the one-sector SSM robust to an extension to two or more sectors (i.e., two or more distinct produced goods)

   [**] Take-Home Exercise 6: From Verbally Stated Growth Problem to Quantitative Growth Model, Due: Friday, October 23, 12:10 (beginning of class). HAND-OUT

   [**] Take-Home Exercise 7: Long-Run Impact of Taxes in a Simple One-Sector Descriptive Growth Model, Due: Friday, October 30, 12:10 (beginning of class). HAND-OUT

   Required Readings:

   • [**] L. Tesfatsion, "The Basic Solow-Swan Descriptive Growth Model". PACKET

   • [**] L. Tesfatsion, "Summary: The Basic Solow-Swan Descriptive Growth Model" (Summary of Key Properties and Predictions). PACKET

   • [**] L. Tesfatsion, "An Illustrative Two-Sector Neoclassical Growth Model". PACKET

   Recommended Readings:

   • [ *] 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. ON-LINE

   • [ *] Andrew Abel and Ben Bernanke, op. cit., SECOND HALF of Part-2 chapter titled "Long-Run Economic Growth", which reviews the basic Solow-Swan Descriptive Growth Model.

   • [ *] Barro and Sala-i-Martin, op. cit., chapter titled "Growth Models with an Exogenous Savings Rate" (advanced discussion of the Solow-Swan Descriptive Growth Model).

   • [ *] Romer, op. cit., chapter titled "The Solow Growth Model" (advanced discussion).

   • The Neoclassical Growth Website maintained by the Schwartz Center for Economic Policy Analysis (CEPA) at the New School for Social Research, New York. ON-LINE

   • The Multi-Sector Growth Website maintained by the Schwartz Center for Economic Policy Analysis (CEPA) at the New School for Social Research, New York. ON-LINE

   

   BASIC OPTIMAL GROWTH MODEL

   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 optimal growth models (descriptive and optimal) from a theoretical viewpoint? from an empirical viewpoint?

   [** ] Second In-Class Student-Moderated Discussion: "Promoting Cross-Country Growth and Development: Do Universal Principles Exist?" (pdf,26K). Scheduled for: Thursday, November 5, 2009, 11-12:20pm.

   [**] Take-Home Exercise 8: Optimal Growth and Dynamic Stochastic General Equilibrium (DSGE) Models (pdf,20K). Due: Tuesday, November 10, 11:00 AM (beginning of class). HAND-OUT

   Required Readings:

   • [**] L. Tesfatsion, "A Simple Illustrative Optimal Growth Model". PACKET

   • [**] L. Tesfatsion, "Notes on Hyperbolic Discounting". PACKET

   Recommended Readings:

   • [ *] Barro and Sala-i-Martin, op. cit., chapter titled "Growth Models with Consumer Optimization -- the Ramsey Model" (advanced discussion).

   • [ *] 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(Stress on First Four Sections).

   • The Optimal Growth Website maintained by the Schwartz Center for Economic Policy Analysis (CEPA) at the New School for Social Research, New York. ON-LINE

   

   BASIC OVERLAPPING GENERATIONS MODEL

   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?

   [**] ANSWER OUTLINE for take-Home Exercise 9: Social Security in Overlapping Generations Economies with Storage (pdf,75K). Due: Friday, November 20, 12:10 AM (beginning of class). HAND-OUT

   Required Readings:

   • [**] L. Tesfatsion, "The Basic Pure-Exchange Overlapping Generations Economy". PACKET

   • [**] L. Tesfatsion, "Game Theory: Basic Concepts and Terminology" (pdf,35K). PACKET

   Recommended Readings:

   • [ *] G. Becker, "Family Economics and Macro Behavior" American Economic Review 78 (March 1988), 1-13 (Presidential Address).

   • [ *] Romer, op. cit., "overlapping generations" sections of chapter titled "Infinite Horizon and Overlapping Generations Models" (advanced discussion).

IV. TREATMENT OF EXPECTATIONS IN MACROECONOMIC MODELS

1. 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?

   Required Reading:

   • (11/12/09) [**] L. Tesfatsion, "Introduction to Rational Expectations" (pdf,115K). PACKET

   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, the study of "believably simple people (coping) with incredibly complex situations."

     [ *] A. Blinder, "Keynes, Lucas, and Scientific Progress", American Economic Review (pdf, 969K), 77 (May 1987), pp. 130-136. ON-LINE

     [ *] R. Lucas, Jr., and T. Sargent, "After Keynesian Macroeconomics", Chapter 7 (pp. 166-180) in T. M. Havrilesky, Modern Concepts in Macroeconomics, Harlan-Davidson, Illinois, 1985.

     Note: This famous article, an intentionally provocative assertion that "rational expectations is the only game in town," dramatically heated up the rational expectations debate in the 1980s.

     [ *] Alan P. Kirman, "Whom or What Does the Representative Individual Represent?" Journal of Economic Perspectives 6 (Spring 1992), 117-136.

     Note: The Kirman article has been a highly influential critique of the use of "representative agents" in macroeconomic theorizing in general and rational expectations theorizing in particular.

   Other Suggested Readings and Websites

   

2. 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?

   [**] Take-Home Exercise 10: Policy Implications of Rational Expectations. Due: Friday, December 4, 12:10 AM (beginning of class). HAND-OUT

   IMPORTANT NOTE: Please recall from the exercise information provided on the Econ 502 Homepage and from in-class discussion that exercises are due in at the beginning of class on the due date. Late assignments will not be accepted -- no exceptions.

   Required Readings:

   • [**] L. Tesfatsion, "Notes on the Lucas Critique, Time Inconsistency and Related Issues" (pdf,92K). PACKET

   Recommended Readings:

   • [ *] F. S. Mishkin,"The Rational Expectations Revolution", A review article of Preston J. Miller, ed., The Rational Expectations Revolution: Readings from the Front Line," Journal of International and Comparative Economics, Volume 5, 1996 (pdf,1026K). ON-LINE

   • [ *] Peter Howitt, "Monetary Policy and the Limitations of Economic Knowledge", pp. 347-367 in David Colander (Ed.), Post Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006.

   • [ *] K. Hoover, The New Classical Macroeconomics..., op. cit., Chapter 8: "Econometrics and the Analysis of Policy" (pp. 185-202).
     Note: This interesting chapter examines the Lucas Critique and provides an assessment of contrasting attempts to apply new classical macro principles to the econometric analysis of policy.

   Other Suggested Readings and Websites

V. DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM MODELS AND TAYLOR RULES

1. RECENT DEVELOPMENTS IN 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: Output Validation? Input Validation?
   • Re-evaluation needed in view of recent econ/financial crisis?

   [** ] Third In-Class Student-Moderated Discussion: "What's the Post-Crisis Scoop on Dynamic Stochastic General Equilibrium Models -- Retain, Revise, or Reject?" (pdf,23K). Scheduled for: Tuesday, December 1, 2009, 11-12:20pm.

   Required Reading:

   • [**] Jana Kremer, Giovanni Lombardoy, Leopold von Thaddenz, and Thomas Werner, "Dynamic Stochastic General Equilibrium Models as a Tool for Policy Analysis" (pdf,161K), CESifo Economic Studies, November 28, 2006, 26pp. ON-LINE
     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.

     [**] C. E. Tovar, "DSGE Models and Central Banks" (pdf,270), BIS Working Paper No. 258, Bank for International Settlements, September 2008, 29pp. ON-LINE

     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.

   Recommended Reading:

   • [ *] Frank Smets and Raf Wouters, "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area" (pdf,570K), National Bank of Belgium Working Paper, 2003, 71pp. ON-LINE
     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.

     [ *] Charles I. Jones, "The Global Financial Crisis: Overview" (pdf,214), a Supplement to Macroeconomics (W.W.Norton), May 22, 2009. ON-LINE

     [ *] Kristopher Gerardi, Andreas Lehnert, Shane Sherlund, and Paul Willen, "Making Sense of the Subprime Crisis" (pdf,494), Brookings Papers on Economic Activity, Fall 2008.

   

2. 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 Readings:

   • [**] Athanasios Orphanides, "Taylor Rules" (pdf,105K), Finance and Economics Discussion Series 2007-18, Federal Reserve Board, January 2007. ON-LINE

   Recommended Readings:

   • [ *] John B. Taylor, "Discretion Versus Policy Rules in Practice" (pdf,1.7M), Carnegie-Rochester Conference Series on Public Policy 39, 1993, pp. 195-214. ON-LINE

VI. PERMITTING ENDOGENOUS COORDINATION IN MACROECONOMIC MODELS

1. POST-WALRASIAN MACROECONOMICS

   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?

   Required Readings:

   • [**] L. Tesfatsion, "Walrasian General Equilibrium: Benchmark of Coordination Success?" (pdf,72K). PACKET

   • [**] L. Tesfatsion, "NonWalrasian Equilibrium: Illustrative Examples" (pdf,187K). PACKET

   Recommended Readings:

   • [ *] George A. Akerlof, "Behavioral Macroeconomics and Macroeconomic Behavior", The American Economic Review, Volume 92, No. 3, June 2002, pages 411-433.
     Note: This is a revised version of the Nobel Lecture Akerlof delivered in Sweden on December 8, 2001.

     [ *] Robert Clower and Peter Howitt, "Taking Markets Seriously: Groundwork for a Post Walrasian Macroeconomics", Chapter 2 (pp. 21-37) in David Colander (ed.), Beyond Microfoundations: Post Walrasian Macroeconomics, Cambridge University Press, Cambridge, UK, 1996.

     [ *] Samuel Bowles and Herbert Gintis, "Walrasian Economics in Retrospect" (pdf,205K), Quarterly Journal of Economics, November 2000, 1411-1439. ON-LINE

   Other Suggested Readings and Websites

   

2. A CONSTRUCTIVE APPROACH TO MACROECONOMIC COORDINATION

   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 constraints (hindrance or help for achieving macroeconomic coordination?)

   Required Readings:

   • [**] L. Tesfatsion, "Constructive Modeling of Decentralized Market Economies: An Agent-Based Computational Economics Approach" (ppt slides,951K). ON-LINE, IN-CLASS PRESENTATION
     Note: This presentation discusses the potential of 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 the packet reading "Agent-Based Computational Modeling and Macroeconomics" listed below as a recommended reading.

     [**] B. LeBaron and L. Tesfatsion, "Modeling Macroeconomies as Open-Ended Dynamic Systems of Interacting Agents" (pdf,45K) American Economic Review (Papers & Proceedings), Volume 98, No. 2, 2008, 246-250. ON-LINE

     Abstract: This article 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.

   Recommended Readings:

   • [ *] R. Axtell, Very Large-Scale Multi-Agent Systems and Emergent Macroeconomics (pdf,559K), Lecture Notes, The Brookings Institution, Washington, D.C., 2005. ON-LINE

   • [ *] Giorgio Fagiolo and Andrea Roventini, "On the Scientific Status of Economic Policy: A Tale of Alternative Paradigms" (pdf,437K), Laboratory of Economics and Management (LEM) Working Paper, Sant'Anna School of Advanced Studies, Pisa, Italy, February 2008. ON-LINE
     Abstract: The authors argue that a more fruitful research avenue for macroeconomics than DSGE modeling is to explore alternative theoretical paradigms, such as agent-based modeling, that avoid the strong theoretical requirements of DSGE models.

     [ *] Peter Howitt, "Macroeconomics with Intelligent Autonomous Agents" (pdf,181K), Brown University Working Paper, June 1, 2007. ON-LINE

     [ *] Marc Oeffner, "Agent-Based Keynesian Macroeconomics" (Thesis Intro/Refs Only, pdf, 455K), (Entire Thesis, pdf, 3.4MK), Dissertation, Julius-Maximilians-Universität Würzburg, Germany, September 2008.

     Abstract: The 61-page introduction to this thesis provides the most comprehensive survey to date of the existing and potential uses of ACE modeling tools for the development and study of macroeconomic systems. The final chapters of this thesis develop, implement, validate, and study a proof-of-concept monetary macroeconomic model using the SeSAm multi-agent simulation environment. Complete code for this SeSAm implementation can be obtained in a zip file named Dokument1.zip (39M) available here. The thesis and thesis code are also available at Wikipedia: Agent-Based Computational Macroeconomics.

     [ *] L. Tesfatsion, "Agent-Based Computational Modeling and Macroeconomics" (pdf,148K), pp. 175-202 in David Colander (ed.), Post-Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model, Cambridge University Press, Cambridge, UK, 2006. PACKET, ON-LINE

   Other Suggested Readings and Websites

   

3. ILLUSTRATION OF CONSTRUCTIVE MACRO MODELING:
   LABOR INSTITUTIONS AND MACROECONOMIC PERFORMANCE

   Key Questions for In-Class Discussion:

   • Construction of an ACE labor market model with preferential job search and evolution of work-site behaviors
   • What might "equilibrium" mean in such a model?
   • What other types of issues can be addressed?

   Required Readings:

   • [**] L. Tesfatsion, "Labor Institutions and Macroeconomic Performance" (ppt slides,87K). ON-LINE, IN-CLASS PRESENTATION
     Note: This presentation summarizes some of the key findings in the Pingle/Tesfatsion article posted below as a recommended reading.

   Recommended Readings:

   • [ *] M. Pingle and L. Tesfatsion, "Evolution of Worker-Employer Networks and Behaviors Under Alternative Non-Employment Benefits: An Agent-Based Computational Study" (pdf,269K), pp. 256-285 in A. Nagurney (ed.), Innovations in Financial and Economic Networks, Edward Elgar, 2003. ON-LINE

   • [ *] G. Fagiolo, D. Dosi, and R. Gabriele, "Towards an evolutionary interpretation of aggregate labor market regularities" (pdf,387K), in: Cantner, U., Dinopoulos, E. and Lanzillotti, R.F. (Eds.), Entrepreneurship, the New Economy and Public Policy: Schumpeterian Perspectives, Berlin - Heidelberg, Springer Verlag, 2004. ON-LINE

   Other Suggested Readings and Websites

MIDTERM AND FINAL EXAM REVIEW MATERIALS

Important Caution: Please keep in mind that the readings, exercises, and course packet materials for this year's Econ 502 may differ in various ways from the materials assigned for Econ 502 in previous years, and these differences may be reflected in differences in the form and content of the exams. The exam study guides and practice exams provided below from past years are for general guidance only.

Indeed, the Econ 502 course topics substantially changed in Fall 2005 relative to previous years. Consequently, to avoid confusion, no practice exams are presented from years prior to 2005.

Midterm Exam:

• Fall 2009 Midterm Exam Review Guide.

• Practice Midterm Exams:

  • Practice Midterm Exam (with Answer Outline) from Fall 2006

Final Exam:

• Fall 2008 Final Exam Review Guide

• Practice Final Exams:

  • Practice Final Exam (with Answer Outline) from Fall 2008

  • Practice Final Exam (with Answer Outline) from Fall 2007

  • Practice Final Exam (with Answer Outline) from Fall 2006

  • Practice Final Exam (With Answer Outline) from Fall 2005

Copyright © 2009 Leigh Tesfatsion. All Rights Reserved.