SEM0079 - MACROECONOMIC ANALYSIS - 2021/22
Topic outline
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Macroeconomic Analysis
Fabio C. Bagliano
fabio.bagliano@unito.it
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Starting on Monday September 20, lectures will take place "in presence" in room “O. Castellino” (third floor) according to the following weekly schedule:
Monday 10.15 am -1 pm Tuesday 8.30-11 am
Lectures will also be accessible "live" via Webex through the following links (that will remain active until the end of the course):
Monday lectures: https://unito.webex.com/unito/j.php?MTID=m842c4fab7c52c2fca66deb778ebd543d
Tuesday lectures: https://unito.webex.com/unito/j.php?MTID=m043677611d9b60d64fd10732e341842b
Lectures will be recorded and made available on this Moodle page usually on the day after the lecture. Any change of schedule will be communicated on this Moodle page in the “News” section.
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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)
- Blanchard O.J. (2000) "What do we know about macroeconomics that Fisher and Wicksell did not?", Quarterly Journal of Economics, 115, 1375-1409
- Blanchard O.J. (2009) "The state of macro", Annual Reviews of Economics, 1, 209-228
- Kydland F.E. and E.C. Prescott (1990) "Business cycles: real facts and a monetary myth", Quarterly Review, Federal Reserve Bank of Minneapolis, 14(2), 3-18
- Stock J.H. and M.W. Watson (2000) "Business cycle fluctuations in US macroeconomic time series", in J.B. Taylor and M. Woodford (editors), Handbook of Macroeconomics, Volume 1A, Elsevier - (NBER working paper version 1998)
A more recent account of business cycle facts for the USA in the light of the Great Recession (2007-2009) is provided by
- Ng S. and J. Wright (2013) "Facts and challenges from the Great Recession for forecasting and macroeconomic modeling", Journal of Economic Literature, 51(4), 1120-1154
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:
- Hodrick R.J. and E.C. Prescott (1997) "Postwar US business cycles: an empirical investigation", Journal of Money, Credit and Banking, 29(1), 1-16
Information on how the "official" dating of the "expansion" and "recession" stages of the business cycles is determined are available:
- for the USA: from the National Bureau of Economic Research (NBER), with a complete chronology of the US business cycles from 1854, and some methodological notes
- for
the Euro area: from the Centre
for Economic Policy Research
(CEPR), with a business cycle chronology from 1970, and some methodological notes. The most recent statements on the Euro-area business cycle have been released on September 29, 2020 (link) and on March 29, 2021 (link)
The recent experience of business cycle fluctuations in the Euro area and the US is analyzed and compared in:
- European Central Bank (2009) "The latest Euro area recession in an historical context", Monthly Bulletin, November 2009, 97-113 -
- European Central Bank (2011) "Patterns of Euro area And US macroeconomic cycles: What has been different this time?", Monthly Bulletin, May 2011, 69-85
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:
- Samuelson P.A. e R.M. Solow (1960) "Analytical aspects of anti-inflation policy", American Economic Review, 50, 177-194 (especially p. 186-194)
On the history of the Phillips curve and its role in US macroeconomic policy:
- King R.G. (2008) "The Phillips curve and US macroeconomic policy: snapshots 1958-1996", Federal Reserve of Richmond Economic Quarterly Review, 94, Fall
On the use of the standard Phillips curve framework to interpret recent macroeconomic developments:
- Coibion O. and Y. Gorodnichenko (2015) "Is the Phillips Curve alive and well after all? Inflation expectations and the missing deflation", American Economic Journal: Macroeconomics, 7(1), 197-232
- European Central Bank (2014) "The Phillips curve relationship in the Euro Area", Monthly Bulletin, July 2009, 97-113
- Article from The Economist (June 2017) discussing recent US evidence
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:
- Friedman M. (1968) "The role of monetary policy", American Economic Review, 58, p.1-17
- Friedman M. (1977) "Nobel lecture: Inflation and unemployment", Journal of Political Economy, 85, 451-472
More recent empirical assessment of the natural rate idea:
- Blanchard O.J. and L.F. Katz (1997) "What we know and do not
know about the natural rate of unemployment", Journal of Economic
Perspectives, 11 Winter
- Ball L. and N. G. Mankiw (2002) "The NAIRU in theory and practice", Journal of Economic Perspectives, 16 Fall
- Blanchard O.J. (2018) "Should we reject the natural rate hypothesis?", Journal of Economic Perspectives, 32 Winter
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:
- Lucas R.E. Jr. (1973) "Some international evidence on output-inflation trade-offs", American Economic Review, 63, 326-334
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:
- motivation and scientific background
- comment on The Economist October 15, 2011
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:- Fischer S. (1977) "Long-term contracts, rational expectations and the optimal money supply rule", Journal of Political Economy, 85, 191-205
- Taylor J.B. (1979) "Staggered wage setting in a macro model", American Economic Review, 69, 108-113
On the inflation/output variability trade-off:
- Taylor J.B. (1994) "The inflation-output variability trade-off revisited", in J. Fuhrer (ed.) Goals, guidelines and constraints facing monetary policymakers, Federal Reserve Bank of Boston
- Taylor J.B. (2017) "The staying power of staggered wage and price setting models in macroeconomics", in Handbook of Macroeconomics, vol. 2, North-Holland, chapter 25 (working paper version)
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:
- Blanchard O.J. (1981) "Output, the stock market and interest rates", American Economic Review, 71, 131-142
- Dornbusch R. (1976) "Expectations and
exchange rate dynamics", Journal of Political Economy, 84, 1611-1176
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:
- Prescott E.C. (1986) "Theory ahead of business cycle measurement", Quarterly Review, Federal Reserve Bank of Minneapolis, 10(4), 9-22
- Plosser C.I. (1989) "Understanding
real business cycles", Journal of Economic Perspectives, 3, 51-77
- Stadler G.W. (1994) "Real business cycles", Journal of Economic Literature, 32, 1750-1783
- King R.G. and S. Rebelo (2000) "Resuscitating real business cycles", in J.B. Taylor e M. Woodford (editors), Handbook of Macroeconomics, Elsevier (NBER working paper version)
- Rebelo S. (2005) "Real business
cycle models: past, present, future", Scandinavian Journal of
Economics, 107, 217-238
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:
- Romer D. (1993) "The new Keynesian synthesis", Journal of Economic Perspectives, 7, 5-22
- Blanchard O.J. and N.
Kiyotaki (1987) "Monopolistic competition and the effects of aggregate
demand", American Economic Review, 77, 647-666
- Gali J. and Gertler M. (2007) "Macroeconomic modeling for monetary policy evaluation", Journal of Economic Perspectives, 21, 25-45
- Hornstein A. (2007) "Evolving inflation dynamics and the New Keynesian Phillips curve", Federal Reserve of Richmond Economic Quarterly Review, 93, Fall
- Mavroeidis S., M. Plagborg-Moller and J. Stock (2014) "Empirical evidence on inflation expectations in the New Keynesian Phillips curve", Journal of Economic Literature, 52, 124-188
Recent assessments of DSGE modeling in general, and the New Keynesian macroeconomics in particular, can be found in:- Christano L.J., M.S. Eichenbaum and M Trabandt (2018), "On DSGE models", Journal of Economic Perspectives, 32, 113-140
- Gali J. (2018) "The state of New Keynesian Economics: a partial asessment", Journal of Economic
Perspectives, 32, 87-112
8. Unemployment: search and matching models of labor market dynamicsLecture 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
- Hornstein A., Krusell P., G.L. Violante (2005) "Unemployment and Vacancy fluctuations in the matching model: inspecting the mechanism", Federal Reserve Bank of Richmond Economic Quarterly Review
- Hall R. (2005) "Employment
fluctuations with equilibrium wage stickiness", American Economic Review, March
- Pissarides C.A. (2011) "Equilibrium in the labor market with search frictions", American Economic Review
- Elsby M., R. Michaels, D. Ratner (2015) "The Beveridge curve: a survey", Journal of Economic Literature
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Additional material: Perspectives on the "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- Brunnermeier M.C. (2009) "Deciphering the liquidity and credit crunch 2007-2008", Journal of Economic Perspectives, 23, 77-100
The interactions between financial markets and the real economy, and their implications for macroeconomic analysis, are investigated by
- Hall R.E. (2010) "Why does the economy fall to pieces after a financial crisis?" Journal of Economic Perspectives, 24, 3-20
- Gertler M. and S. Gilchrist (2018) "What happened: financial factors in the Great Recession", Journal of Economic Perspectives, 32, 3-30
- Mian A. and A. Sufi (2018) "Finance and business cycles: the Credit-driven household demand channel", Journal of Economic Perspectives, 32, 31-58
A comprehensive account and interpretation of the Great 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.LucasA perspective on the evolution of business cycle theory in the light of the Great Recession is provided by:
- Keohe P.J., V. Midrigan and E. Pastorino (2018) "Evolution of modern business cycle models: accounting for the Great Recession", Journal of Economic
Perspectives, 32, 141-166
A series of articles in The Economist (September-October 2013) on the origins and consequences of the 2007-9 financial crisis
The current recession due to the Covid-19 pandemic is likely to have important consequences on macroeconomics; some of the issues are discussed in this article in The Economist (July 2020).
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This section contains the syllabus of the course, lecture notes and problem solutions.
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