Dynamic Economics in Practice
17 and 18 September 2014, UCL Economics Department.
Course Tutors: Monica Costa Dias (IFS) and Cormac O’Dea (IFS)
Overview
This course provides a practical introduction to solving microeconomic dynamic
optimisation problems. It will ground the discussion around the life-cycle permanent income
model of consumption and savings, a model that has been a key workhorse in both macroand micro-economics. The course has two main goals.
The first goal is to provide a rigorous discussion of recursive methods and how they are used
to solve dynamic optimization problems in economics. We will show that the optimal
allocation of resources over time depends on key characteristics of the problem at hand,
including individual preferences, the dynamics of income or other resources, and economywide characteristics determining, for instance, the amount of uncertainty faced by
individuals or the functioning of insurance and credit markets. The simplest consumptionsavings problem will be introduced first and used to discuss the key features of recursive
solution and simulation methods. It will then be gradually extended to more realistic, but
also more complex setups.
The second goal is to discuss and implement the numerical tools typically used to solve and
simulate dynamic optimisation problems. Recursive methods provide a powerful framework
for the numerical solution of dynamic problems and computational algorithms heavily rely
on them. The tight connection between the recursive solution methods and the numerical
approach to the solution and simulation of the problems will be highlighted. We will
examine numerical techniques to solve equations and approximate, interpolate, integrate
and optimise unknown functions showing, in each case, the relative strengths and
weaknesses of alternative techniques. The numerical tools will then be combined to solve
and simulate problems of different levels of complexity. We will discuss how to use
information about the problem to improve the accuracy of numerical approximations.
The course is a mixture of lectures and applied sessions. Course participants will apply the
various techniques on their computers using MATLAB, based on accompanying code
developed to implement the solution and simulation routines.
Dynamic Economics in Practice
Course programme
Wednesday 17 September
10.00
Registration
10.30 – 12.30 Introduction to the course
The simplest life-cycle consumption-savings problem
12.30 – 13.30 Lunch
13.30 – 15.00 Numerical methods and solution to the life-cycle problem
Practical work
15.00 – 15.30 Coffee break
15.30 – 17.30 Practical work
Income and credit constraints
Practical work
Thursday 18 September
9.30
Tea and coffee
10.00 – 11.30 Markov processes and uncertainty
11.30 – 11.45 Coffee break
11.45 – 12.45 Practical work
12.45 – 13.45 Lunch
13.45 – 15.30 Infinite horizon consumption-savings problem
15.30 – 16.00 Coffee break
16.00 – 17.30 Practical work
Concluding remarks
Required level of knowledge
This is an intermediate-level course that offers a formalised analysis of dynamic
optimisation problems and solutions methods. It requires some previous knowledge of
economic problems and optimisation methods, as well as a sound mathematical
background.
The practical part of the course will use MATLAB. Although prior knowledge of MATLAB is
not required, as it will be introduced for beginners and all exercises will be guided, some
prior experience with some computer software for data analysis or a programming language
is recommended to ensure participants can follow a relatively quick introduction to a new
language.
Dynamic Economics in Practice
References and readings
The material covered in the course combines contributions that can be found in more than one
book. The practical focus is similar to that found in Adda and Cooper (2003). The discussion of the
life-cycle consumption problem and of recursive methods in economics follows Ljungqvist and
Sargent (2004). A more formal account can be found in Stokey and Lucas (1989). Finally, much of the
numerical detail uses Judd (1998). Full references are:
Adda, Jerome and Russell Cooper (2003). Dynamic Economics. Cambridge : MIT Press.
Judd, Kenneth (1998). Numerical Methods in Economics. Cambridge : MIT Press.
Ljungqvist, Lars and Thomas Sargent (2004). Recursive Macroeconomic Theory. 2nd Edition.
Cambridge : MIT Press.
Stokey, Nancy and Robert Lucas (1989). Recursive Methods in Economic Dynamics.
Cambridge: Harvard University Press.