• Dipartimento ESOMAS

    Macroeconomic analysis   2019/2020

    Fabio C. Bagliano 

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    Main topic. The course deals with some key themes of modern macroeconomics, presenting the evolution of business cycle theory from the "neoclassical synthesis" to more recent new-Keynesian interpretations. Fundamental economic concepts will be rigorously illustrated with the aid of formalized models, widely used in various fields of macroeconomics.

    Readings. The course is not based on a textbook. For most topics, lecture notes will be circulated; moreover, for each topic, a set of readings, mostly drawn from scientific international journals and containing the original versions of the models discussed in the lectures, are suggested.  Lecture notes will be made available in the "Teaching Material" section below.

    Background. Working knowledge of microeconomics and macroeconomics at the level of three-year undergraduate courses is required. The formalized analysis of macroeconomic models requires familiarity with the mathematical and statistical tools acquired in the three-year undergraduate program in Economics. In particular, extensive use of differential calculus and constrained optimization will be made. 

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    A file with this syllabus can be found in the "Teaching material" section below.

    Introductory readings: theories and facts.

    This section provides some references on the theoretical developments of macroeconomics (and business cycle analysis in particular) and on the main features of observed business cycle fluctuations.

    Critical assessments of the evolution of macroeconomic theory are provided by: (these papers require some knowledge of the models that will be studied in the course; therefore, the suggestion is to quickly browse through them at the beginning, and come back later for a more thorough reading)

    The cyclical properties of the main macroeconomic time series for the USA in the post-World War II period (the "stylized facts" of the business cycle that theory should account for) are analyzed in:

    A more recent account of business cycle facts for the USA in the light of the Great Recession (2007-2009) is provided by

    Some of the papers above, and many others in the literature on this issue, use "filtering" techniques to separate cyclical fluctuations in aggregate macroeconomis series from their trend behavior. For technical details on the most widely used filtering procedure, the "Hodrick-Prescott (HP) filter" see:

    Information on how the "official" dating of the "expansion" and "recession" stages of the business cycles is determined are available:

    The recent experience of business cycle fluctuations in the Euro area and the US is analyzed and compared in:

    A short introductory handout on business cycle analysis is available in the "Teaching material" section below.

    Articles from The Economist :

    • September 2008: discussing the definition and measurement of "recessions"
    • August 2014 and May 2016: evaluating the length of the current US expansion in the light of recent business cycle experience
    • July 2019: again on the length of the (still) current US expansion

    1. The "neoclassical synthesis"

    Fully developed in the 1950s, the so-called "neoclassical synthesis" has been the basic paradigm for the interpretation of macroeconomic phenomena until the end of the 1960s. Based on the Keynesian model of income determination as interpreted by J.R. Hicks ("Mr. Keynes and the Classics. A suggested interpretation", Econometrica, 1937) and F. Modigliani ("Liquidity preference and the theory of interest and money", Econometrica, 1944), with the addition of simple assumptions on the changes over time of wages and prices suggested by A.W. Phillips ("The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957", Economica,1958), the model aimed at integrating the "classical" analysis of the long-run with the "keynesian" theory of short-run fluctuations. 

    On the subsequent utilization of the Phillips curve as a "menu" for policy choices:

    On the history of the Phillips curve and its role in US macroeconomic policy:

    On the use of the standard Phillips curve framework to interpret recent macroeconomic developments:

    2. The "natural rate of unemployment" and the long-run Phillips curve

    The first fundamental critiques of macroeconomic policies based on a permanent trade-off between inflation and unemployment, and the development of the concepts of "natural rate of unemployment" and the "long-run Phillips curve" were put forward by M. Friedman and E. Phelps at the end of the 1960s. A simple formalization of Friedman's view is in the lecture notes 1 (available in the "Teaching material" section below). The original papers are:

    More recent empirical assessment of the natural rate idea:

    Articles from The Economist :

    • September 2011 and August 2017: making use of the "natural rate of unemployment" concept in discussing US Federal Reserve's monetary policy goals

    3. Rational expectations and the "New Classical Macroeconomics".

    The introduction in macroeconomic models (featuring the natural rate of unemployment) of the assumption of "rational expectations" in the behavior of economic agents had dramatic consequences for the theory of economic policy, usually associated with the "new classical macroeconomics" school of the 1970s and 1980s.  A formalization of the rational expectations hypothesis and a comparison with the (older) assumption of "adaptive" expectations is in section 1 of lecture notes 2 (in "Teaching material") in the context of a model of "hyperinflation". In the lecture notes 2 (section 2) we study a macroeconomic model making use of rational expectations due to R.E. Lucas, which  is also an example of the wide-ranging "Lucas critique" of traditional macroeconom(etr)ic models used for policy analysis:

    The main implications of this model for business cycle theory and the role for macroeconomic stabilization policies are extended by the new classical macro models analyzed in lecture notes (2, section 3). See in particular:

    • Sargent T.J. and N. Wallace (1976) "Rational expectations and the theory of economic policy", Journal of Monetary Economics, 2, 169-183
    • Barro R.J (1976) "Rational expectations and the role of monetary policy", Journal of Monetary Economics, 2, 1-32
    • Lucas R.E. and T.J. Sargent (1978) "After Keynesian macroeconomics", in After the Phillips curve: persistence of high inflation and high unemployment, Federal Reserve Bank of Boston

    Nobel prize for Economics 2011 awarded to T.J. Sargent and C.A. Sims for their contributions to empirical macroeconomics:

    Hints for the answers to the problem set in lecture notes 2 will be available in "Teaching material".

    4. Nominal rigidities, rational expectations and stabilization policies.

    A stabilization role for macroeconomic (especially monetary) policies can be found even in a rational expectations framework if nominal rigidities are introduced in the wage-setting or price-setting mechanisms, as shown by the models illustrated in lecture notes 3 (in "Teaching material"). Original papers:

    On the inflation/output variability trade-off:

    A recent assessment of sticky wages/prices models is provided by:

    5. Dynamic macroeconomic models of real-financial interactions

    The rational expectations hypothesis has been widely used also in macroeconomic models (not of the new classical variety) focusing on the interactions between the real and the financial sectors of the economy. In the lecture notes 4 (in "Teaching material"), two classic examples are presented: a IS-LM model extended to allow for a stock market (Blanchard) and the Dornbusch's "overshooting" nodel of the exchange rate. Original papers:

    Hints for the answers to the problem set in lecture notes 4 will be available in "Teaching material".

    6. Real business cycle theory

    Building on the fundamental theoretical framework of the new classical macro (therefore viewing business cycles as an equilibrium phenomenon), the emphasis is shifted by real business cycle (RBC) theorists onto technological shocks as the main source of fluctuations. Among early contributions:

    Survey papers with assessments of the RBC literature:
    Slides are available in "Teaching material".

    7. New Keynesian Macroeconomics: macroeconomic implications of imperfections in the goods and labor markets

    Lecture notes 5.1 and 5.2 are available in "Teaching material"

    Recent attempts to rebuild business cycle theory on Keynesian ideas (but with rigorous microeconomic foundations) has produced several models focusing on various market imperfections (imperfect competition, real and nominal rigidities). These models provide the theoretical framework for the dynamic stochastic general equilibrium (DSGE) models also used for policy analysis. Some early models exploring the macroeconomic and policy consequences of imperfections in the goods and labor markets are presented in:

    A focus on the implications for monetary policy is provided by:

    Implications for inflation dynamics anf its interaction with the output gap are discussed in:
    Recent assessments of DSGE modeling in general, and the New Keynesian macroeconomics in particular, can be found in:

    8. Unemployment: search and matching models of labor market dynamics

    Lecture notes 6 are available in "Teaching material", together with (extended) answers to the problem set.

    The evidence of sizeable flows of workers getting into and out of unemployment motivated the development of models of labor market dynamics based on the process of search by agents on the market. The original insights have been developed by P. Diamond, D. Mortensen and C. Pissarides (DMP model). A comprehensive treatment can be found in:

    • Pissarides C.A. (2000) Equilibrium Unemployment Theory, Second edition, ch. 1-3
    The basic DMP model and its implications are presented and discussed by:
    A recent survey of theory and evidence on the relationship between unemployment and vacancies is provided by:

    Additional material: Perspectives on the recent "Great Recession" 2007-2009.

    A good account of the early stages of the financial crisis, focusing on the liquidity squeeze and credit crunch occurred in the US in 2007 and 2008 is provided by

    The interactions between financial markets and the real economy, and their implications for macroeconomic analysis, are investigated by

    A comprehensive account and interpretation of the recent recession can be found in

    • Hall R.E. (2011) "The long slump", American Economic Review, 101, 431-469

    Recent economic and financial developments raised deep criticisms of standard models used in macroeconomics and financial economics.
    A summary of the earlier debate is offered by a series of articles in
    The Economist (July 2009) with a reply by R.Lucas

    A perspective on the evolution of business cycle theory in the light of the Great Recession is provided by:

    A series of articles in The Economist (September-October 2013) on the origins and consequences of the recent financial crisis

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    This section contains the syllabus of the course, lecture notes and problem solutions.