Econ 602 Syllabus
Course Section One (First Five Weeks)

Advanced Macro Theory: Economic Growth

Syllabus Last Updated: 21 March 2003

Latest Section Offering: Spring 2003 (First Five Weeks)

Econ 602 Home Page (Course Section One)

Section One Instructor:

Professor Leigh Tesfatsion

Department of Economics/Heady 375

Iowa State University

Ames, Iowa 50011-1070

(515) 294-0138

http://www.econ.iastate.edu/tesfatsi/

tesfatsi@iastate.edu

Office and Office Hours: Heady 375, TR 3:40-5pm, and by appointment

Section One Objectives

A basic goal of macroeconomic theorists is to understand how key macro variables (employment, output, price levels,...) change over time. One particular concern is economic growth, the relative change in the size of economies over time as measured (for example) by real per capita gross domestic product. At present, disagreements remain concerning the primary determinants of long-run economic growth for decentralized market economies. Another unresolved issue is the need to explain the lack of convergence of growth rates among world economies. Major disagreements also persist concerning the extent to which government policy makers can influence economic growth, and the extent to which they ought to do so.

During the first five weeks of Econ 602 we will examine several influential economic growth models in an attempt to understand fundamental agreements and disagreements that are shaping much of the current debate among macroeconomists specializing in economic growth. Although careful attention will be paid to basic technical modelling aspects, the main stress of this section of Econ 602 will be on the usefulness of alternative economic growth models for the examination of empirically substantive issues.

Section One Topics:

1. Economic Growth: Overview
2. Basic Modelling Concepts
3. Neoclassical Aggregate Growth Models
   1. Descriptive Growth Models
   2. Optimal Growth Models
4. Overlapping Generations (OG) Economies
   1. The Basic Pure Exchange OG Economy
   2. The Role of Government in OG Economies
5. New Growth Models

Recquired and Recommended Materials

• Required Materials (Closed Reserve, Econ/Soc Reading Room, Heady 368):
  

  • Various chapters from David Romer (Advanced Macroeconomics, McGraw-Hill, Second Edition, 2001, ISBN: 0-07-2312855-4) will be required or recommended by each section of this year's team-taught Econ 602. A copy of the Romer text has been placed on closed reserve, and copies of the Romer text have been ordered by the bookstore for students wishing to purchase it.

  • Other required materials will consist of a selection of readings (book chapters, journal articles, lecture notes, ... ) either on closed reserve in the Reading Room (Heady 368) or handed out in class.

• Reference Materials (Closed Reserve, Econ/Soc Reading Room, Heady 368):

  • Andrew B. Abel and Ben S. Bernanke, Macroeconomics, Addison-Wesley, Fourth Edition, 2001. [Intermediate macro review]
  • Robert Barro and X. Sala-i-Martin, Economic Growth, McGraw-Hill, Inc., 1995. [ISBN 0-07-003697-7]
  • Olivier J. Blanchard and Stanley Fischer, Lectures on Macroeconomics, MIT Press, 1989.
  • George Feiwel (ed.), Issues in Contemporary Macroeconomics and Distribution, State University of New York, Albany, 1985 (paperback).
  • Kevin D. Hoover, The New Classical Macroeconomics: A Skeptical Inquiry, Basil Blackwell, c. 1988, reprinted in paperback in 1991, 1992 (ISBN 0-631-17263-7)
  • N. Gregory Mankiw and D. Romer, eds., New Keynesian Economics, Volumes 1 and 2, MIT Press, Cambridge, 1991.
  • George McCandless, Jr., with Neil Wallace, Introduction to Dynamic Macro Theory: An Overlapping Generations Approach, Harvard University Press, Cambridge, MA, 1991. [Middle-brow theoretical treatment of the OG model.]
  • Wallace C. Peterson and Paul S. Estenson, Income, Employment, and Economic Growth, W. W. Norton and Co., New York, Seventh Edition, 1992. [Intermediate macro review]
  • David Romer, Advanced Macroeconomics, McGraw-Hill, Second Edition, 2001.
  • Steven Sheffrin, The Making of Economic Policy: History, Theory, and Politics, Basil Blackwell, Cambridge, MA, paperback edition 1991.
  • Nancy Stokey, Robert Lucas, and Edward Prescott, Recursive Methods in Economic Dynamics, Harvard University Press, Cambridge, 1989.
  • Leigh Tesfatsion, Syllabus of readings for Econ 502. [Master's level macro review.]

• On-Line and Library Resources:

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

  • Leigh Tesfatsion, Macro Source Materials: This site provides an annotated list of pointers to a variety of online and library 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.

Detailed Outline of Section One Topics, In-Class Discussion Questions, and Required and Recommended Readings

Please Note: The exact selection of required readings for Section One of Econ 602 will depend on the interests and backgrounds of the students. The list below is tentative and incomplete.

Required readings will be marked with a double asterisk [**]. The required readings contain basic material for answering exam questions and exercises. All required readings will be listed in a suggested reading order, and copies of these readings will either be handed out in class or will be available on closed reserve in the Econ/Soc Reading Room, Third Floor, Heady Hall, Room 368.

Recommended readings will be marked with a single asterisk [*]. Recommended readings cover material of a more general contextual nature that might be useful for answering exam questions and exercises.

Additional materials (required readings, recommended readings, lecture notes, exercises, discussion questions,...) might be incorporated into this on-line syllabus as the course section proceeds. Such materials will be marked on the syllabus with an "updated" or "new" icon, respectively, for at least one week following their incorporation, and their incorporation 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. ECONOMIC 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?

Take-Home Exercise 1 (Pass+/Pass/Fail, Due January 17):

"What in the World is Going On? (And What Do Economic Growth Theorists Have to Say About It?" (Hand-Out)

Required and Recommended Readings:

• [**] N. Gregory Mankiw, "A Quick Refresher Course in Macroeconomics," Journal of Economic Literature 28 (December 1990), 1645-1660. CLOSED RESERVE
• [**] Robert Barro and Xavier Sala-i-Martin, op. cit., Introduction (pp. 1-13). BOOK ON CLOSED RESERVE
• [**] Symposium on "What Have We Learned from Recent Empirical Growth Research?," with comments by R. Hall and C. Jones, X. Sala-i-Martin, J. Sachs and A. Warner, The American Economic Review: Papers and Proceedings 87 (May 1997). CLOSED RESERVE.
• [**] Jonathan Temple, "The New Growth Evidence," Journal of Economic Literature, Vol. XXXVII (March 1999), pp. 112-156. [The focus of this excellent 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.] CLOSED RESERVE

• [*] Andrew Abel and Ben Bernanke, op. cit., Chapter 6:Long-Run Economic Growth (pp. 205-241). [Intermediate macro review.] BOOK ON CLOSED RESERVE.
• Benjamin R. Barber, Jihad vs. McWorld, Ballantine Books, 1995, 2001 (paperback edition with new introduction). [From a Los Angeles Times Book Review: "(A) lucid look at what the (author) insists is the underlying conflict of our times: religious and tribal fundamentalism versus secular consumerist capitalism."]
• Nauro F. Campos and Fabrizio Coricelli, "Growth in Transition: What We Know, What We Don't, and What We Should," Journal of Economic Literature, Volume XL, Number 3 (September 2002), 793-836. [This study examines empirical evidence from 1990 through 1999 relating to the growth performance of transition economies, i.e., economies transiting from central planning to market economies.]
• William Easterly, The Elusive Quest for Growth, The MIT Press, Cambridge, MA, 2002 (paper). See also Romain Wacziarg, "Review of Easterly's `The Elusive Quest for Growth'," Journal of Economic Literature, Volume XL, Number 3 (September 2002), 907-918. [From the publisher: "Since the end of World War II, economists have tried to figure out how poor countries in the tropics could attain standards of living approaching those of countries in Europe and North America. A myriad of remedies has not delivered the solutions promised. The problem is not the failure of economics, William Easterly argues, but the failure to apply economic principles to practical policy work."]
• Wallace Peterson and Paul Estenson, op. cit., Chapters on growth, business cycles, and forecasting. [Intermediate macro review.] BOOK ON CLOSED RESERVE
• [*] George Feiwel, op. cit., "Quo Vadis Macroeconomics? Issues, Tensions, and Challenges," Chapter 1 (pp. 1-100). [Thoughtful critique, still highly relevant for macro today despite the 1985 publication date. Worth several careful readings.] BOOK ON CLOSED RESERVE
• Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The Battle for the World Economy, Simon and Schuster, 2002, ISBN: 0-684-83569-X (paperback). [From the publisher: "The Pulitzer-prize winning author (Yergin) joins a leading expert on the global economy (Stanislaw) to present an incisive narrative of the risks and opportunities that are emerging as the balance of power shifts around the world between governments and markets -- and the battle over globalization comes front and center. (This book) is essential for understanding the struggle over the `rules of the game' for the twenty-first century."]

II. BASIC MODELLING CONCEPTS

Key Questions for In-Class Discussion:

• Some essential facts about differential (difference) systems of equations and sensitivity analysis
• Currently most theoretical models used to study economic growth take the form of systems of differential (or difference) equations. Is this the only option? the best option?
• What is the most appropriate unit of analysis for economic growth theories? Should it be countries? regions? individual people?
• Currently much of the theoretical economic growth literature presumes a high degree of rationality on the part of individual economic agents. Is individual rationality a reasonable benchmark? Or should individual rationality instead be treated as a testable hypothesis?
• Currently much of the theoretical economic growth literature presumes that markets are in continual equilibrium. Is market equilibrium a reasonable benchmark? Or should market equilibrium instead be treated as a testable hypothesis?

In-Class Discussion Exercise (Not Graded):

Using the Classic Domar Economic Growth Model to Illustrate Basic Ideas About Differential Systems and Phase Portraiture. (Hand-Out)

Take-Home Exercise 2 (Team Exercise, 16 Points, Due January 24):

Using a simple two-state economic growth model with inventory accumulation to illustrate basic ideas about differential systems and phase portraiture. (Hand-Out)

Required and Recommended Readings:

• [**] Leigh Tesfatsion, "Notes on Differential Equations." HAND-OUT
• [**] Leigh Tesfatsion, "Macrodynamic Models in Equation Form: General Structural Considerations." HAND-OUT

• [*] Leigh Tesfatsion, "Notes on Comparative Statics." HAND-OUT
• [*] Barro and Sala-i-Martin, op. cit., "Appendix on Mathematical Methods," pp. 462-517. [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, etc.).]
• [*] Russell Cooper, "Dynamic Programming: An Overview" (pdf,19pp) February 14, 2001. [Clear basic introduction to dynamic programming, illustrated by economic examples.]
• [*] Gianluca Violante, "Notes on Discrete Time Stochastic Dynamic Programming" (pdf,14pp) Spring 2000. [More advanced technical introduction to dynamic programming, including careful presentations of the Banach fixed pointed theorem, Blackwell's Sufficiency theorem, etc. Should be accessible to students with a good background in advanced calculus.]
• N. Stokey and R. E. Lucas, Jr., Recursive Methods in Economic Dynamics, Harvard University Press, 1989.

III. NEOCLASSICAL AGGREGATE GROWTH MODELS

III.A Descriptive Growth Models:

Key Questions for In-Class Discussion:

• Basic issue addressed by the one-sector Solow-Swan descriptive growth model (SSM): Under what conditions can full employment of all resources be maintained in the long run, given the capacity-creating effects of net investment?
• Earlier growth models (e.g., Domar) assumed capital and labor must be used in rigid proportions. How does the SSM relax this assumption?
• Is the SSM an equilibrium model?
• Are economic agents in the SSM optimizers?
• How can the basic SSM in level form be transformed into per-capita form?
• Why does a stationary solution k* always exist for the per-capita SSM? Why is k* unique?
• Does k* have any special economic significance?
• Is k* locally stable? globally stable? What explains the stability properties of k*?
• What are the basic predictions of the SSM regarding short-run and long-run growth rates of economies?
• What exogenously specified aspects of the SSM, if changed, would lead to long-run level effects (e.g., effects on the long-run level of per capita output) and/or long-run growth effects (e.g., effects on the long-run growth rate of per capita output)?
• How has the SSM been extended to include technological change affecting labor-embodied productivity? total factor productivity?
• What is the basic "Solow growth accounting equation," and how has it been used empirically to measure technological change?
• Does the introduction of technological change affect the basic properties of the SSM (i.e., dynamic properties, level effects, growth effects)?
• Why do "endogenous growth" theorists claim that even this extended SSM fails to provide an adequate explanation for long-run growth?
• How has the SSM been extended to include factor markets?
• Are the key properties and implications of the SSM with factor markets robust against extension to two or more sectors (i.e., two or more produced goods)?

Take-Home Exercise 3 (Team Exercise, 12 Points, Due 12:10pm, Friday, January 31):

Investigation of the dynamic properties of a Solow-Swan growth model modified to have an endogenous population growth rate dependent on the real wage rate. (Hand-Out)

Required and Recommended Readings:

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

• [*] L. Tesfatsion, "An Illustrative Two-Sector Neoclassical Growth Model." HAND-OUT
• [*] Barro and Sala-i-Martin, op. cit., Chapter 1:Growth Models with Exogenous Savings Rate (the Solow-Swan Model), pp. 14-58. BOOK ON CLOSED RESERVE
• [*] Romer, op. cit., Chapter 1:The Solow Growth Model (pp. 5-46, focus on pp. 1-35). BOOK ON CLOSED RESERVE
• [*] R. Solow, "Growth Theory and After," American Economic Review 78 (June 1988), 307-317. CLOSED RESERVE
• E. Drandakis, "Factor Substitution in the Two-Sector Growth Model," Review of Economic Studies 30 (1963), 217-228.
• E. Prescott, "Robert M. Solow's Neoclassical Growth Model: An Influential Contribution to Economics," Scandinavian Journal of Economics 90 (1988), 7-12.
• R. Solow, Growth Theory, Oxford University Press, Oxford, 1970.

III.B 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 necessary conditions must be satisfied by any solution to the optimal growth model? What is their economic interpretation?
• What does the phase portrait for the optimal growth model look like?
• What is the general meaning of a "transversality condition"? How how can the form of the transversality condition be determined for optimal growth problems with different types of boundary conditions?
• What are the advantages and limitations of neoclassical growth models (descriptive and optimal) from a theoretical viewpoint? from an empirical viewpoint?

Take-Home Exercise 4 (Team Exercise, 12 Points, Due 12:10pm, Friday, February 7):

Relationship of the "golden rule" savings rate to the savings rate generated by optimizing consumers in an optimal growth model. (Hand-Out)

Required and Recommended Readings:

• [**] L. Tesfatsion, "A Simple Illustrative Optimal Growth Model." HAND-OUT
• [**] L. Tesfatsion, "Notes on Hyperbolic Discounting." HAND-OUT
• [**] L. Tesfatsion, "Scope and Limitations of Neoclassical and Optimal One-Sector Growth Models." HAND-OUT

• [*] Barro and Sala-i-Martin, op. cit., Chapter 2:Growth Models with Consumer Optimization -- the Ramsey Model (pp. 59-95). BOOK ON CLOSED RESERVE
• [*] 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). CLOSED RESERVE
• [*] Romer, op. cit., Chapter 2:Infinite Horizon and Overlapping Generations Models (pp. 47-74 only). BOOK ON CLOSED RESERVE
• Policies for Long-Run Economic Growth: A Symposium sponsored by the Federal Reserve Bank of Kansas City, August 1992, edited collection of articles by A. Greenspan, M. Darby, C. Plosser, N. G. Mankiw, L. Summers, R. Barro, and S. Fischer, among others.

IV. OVERLAPPING GENERATIONS (OG) ECONOMIES

IV.A The Basic Pure Exchange OG Economy:

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?
• Why does the first welfare theorem fail for the OG economy as conventionally formulated -- that is, why is inefficiency still a potential problem for the basic OG economy even if a competitive market pricing system is introduced?
• Does this failure of the first welfare theorem for the basic OG economy have any important ramifications for real-world economies?

Required and Recommended Readings:

• [**] L. Tesfatsion, Notes on the Basic Pure Exchange OG Economy. HAND-OUT

• [*] G. Becker, "Family Economics and Macro Behavior," American Economic Review 78 (March 1988), 1-13 (Presidential Address). CLOSED RESERVE
• A. Auerbach, J. Gokhale, and L. Kotlikoff, "Generational Accounting: A Meaningful Way to Evaluate Fiscal Policy," Journal of Economic Perspectives 8 (Winter 1994), 73-94. [Critiqued by R. Haveman, "Should Generational Accounts Replace Public Budgets and Deficits?," Ibid., 95-111.]
• David de la Croix and Philippe Michel, A Theory of Economic Growth: Dynamics and Policy in Overlapping Generations, Cambridge University Press, Cambridge, UK, 2002. [In-depth analysis of the overlapping generations model and its implications for major policy issues such as the reduction of public debt, the financing of social security, the taxation of capital and bequests, and the design of educational systems.]
• David Gale, "Pure Exchange Equilibrium of Dynamic Economic Models", Journal of Economic Theory 6 (1973), 12-36. [Famous paper that first rigorously demonstrated the failure of the first welfare theorem for the overlapping generations model.]
• J. Geanakoplos and H. M. Polemarchakis, "Overlapping Generations," in Handbook of Mathematical Economics, Vol. IV (1991), 1899-1960. [Technical introduction to the math econ literature using OG models.]
• G. McCandless, with N. Wallace, Introduction to Dynamic Macroeconomic Theory: An Overlapping Generations Approach, op. cit.. [Middle-brow theoretical treatment of the OG model.] BOOK ON CLOSED RESERVE
• P. Samuelson, "An Exact Consumption-Loan Model of Interest With or Without the Social Contrivance of Money," Journal of Political Economy 66 (1958), 467-482. [Seminal paper that first introduced the overlapping generations model.]
• M. Shubik, "Society, Land, Love, or Money: A Strategic Model of How to Glue the Generations Together," Journal of Economic Behavior and Organization 2 (1981), 359-385. [An interesting discussion of the intergenerational equity and efficiency issues raised by the OG model, but watch out for an unusually large number of typographical errors.]

IV.B The Role of Government in OG Economies:

Key Questions for In-Class Discussion:

• To what extent can inefficiency in OG economies be alleviated or even eliminated by suitably designed government interventions?
• To what extent can inefficiency in OG economies be alleviated or even eliminated by suitably designed private institutions?

Required and Recommended Readings:

• [*] L. Tesfatsion, "Notes on Government Intervention in Pure Exchange OG Economies." HAND-OUT
• [*] Romer, op. cit., Chapter 2:Infinite Horizon and Overlapping Generations Models (pp. 75-97). [The Diamond OG model.] BOOK ON CLOSED RESERVE.
• P. Diamond, "National Debt in a Neoclassical Growth Model," American Economic Review 55 (1965), 1126-1150.
• J.-M. Grandmont, "On Endogenous Competitive Business Cycles," Econometrica 53 (1985), 995-1045.
• M. Pingle and L. Tesfatsion, "Active Intermediation in Overlapping Generations Economies with Production and Unsecured Debt," Macroeconomic Dynamics 2 (1998), 183-212. A preprint is available online [ (pdf,600K), (ps,297K)]. [This paper demonstrates that the inefficient competitive equilibria arising in the types of overlapping generations economies studied by Diamond (AER, 1965) and Tirole (Econometrica, 1985) can be eliminated if the Walrasian auctioneer, passively focused on coordination of demand and supply, is replaced by active profit-seeking private corporate intermediaries.]
• M. Pingle and L. Tesfatsion, "Active Intermediation in a Monetary Overlapping Generations Model," Journal of Economic Dynamics and Control 22 (1998), 1543-1574. A preprint is available online [ (pdf,590K), (ps,313K).] [This paper demonstrates that the inefficient competitive equilibria arising in the type of monetary overlapping generations economy studied by Grandmont (Econometrica, 1985) can be eliminated if the Walrasian auctioneer, passively focused on coordination of demand and supply, is replaced by active profit-seeking private corporate intermediaries.]
• J. Tirole, "Asset Bubbles and Overlapping Generations: A Synthesis," Econometrica 53 (1985), 1499-1528. [NOTE: This is the corrected reprint of an earlier version of the paper appearing in Econometrica 53 (l985) which had sections deleted due to printer error.]

V. NEW GROWTH MODELS