Econ 208
Marek Kapicka
Lecture 1
Introduction

What is this course about?


Analysis of macroeconomic policies

Government Spending



Taxation and government debt
Monetary policy
Banking and financial intermediation
We will use micro-founded macroeconomic models to study those issues

Administration

Classes: MW 9:30-10:45

My email: mkapicka@econ.ucsb.edu

Office hours: TTh 10:30-11:30, NH
3052

Course homepage: http://econ.ucsb.edu/~mkapicka/E208.html

Administration

TA
Xintong Yang (lemon0215@gmail.com)
TA sessions: Thursdays 3:00-3:50 & 4:00- 4:50
GIRV 1116

Textbook
Macroeconomics , by Matthias Doepke, Andreas
Lehnert, and Andrew Sellgren

Administration



5 problem sets
4 best ones count
25 % of the final grade
Midterm (May 6, in class)
No make-up
25 % of the final grade
Closed book, closed notes
Final (June 12, 9-11)
50 % of the final grade
Closed book, closed notes

Outline of the course
1.
2.
Introduction: A basic framework
1.
Government Policies
The Effects of Government Spending
2.
3.
4.
Government Taxation and Government
Debt
Monetary Policy
Banking and Financial Intermediation

Per Capita Real GDP (in 2000 dollars) for the United
States, 1900-2008

Growth rates g t
 y t y t

1

1

If g t is small, g t
 ln( 1
 g t
)
 ln y t
 ln y t

1

Natural Logarithm of Per Capita Real GDP

The Great Recession

1981-1982 Recession

1. US GDP, Consumption, and Government
Expenditures

2. Total Taxes (black line) and Total Government
Spending (colored line) in the United States, as
Percentages of GDP

2. Recent Recession: Fiscal Policy


2009 Fiscal Stimulus:
$787 billion (~5.5% of GDP)

Tax cuts: $288 billion

Spending on

Healthcare & Education: $238 billion

Infrastructure: $81 billion

4. US History of banking crises



Before 1914: Crises were a frequent phenomenon in the U.S.
National banking era 1863-1913
They have occurred at about 10 year intervals

1873,1884,1890,1893,1896,1907,1914

U.S. National Banking Era Panics


2. How do we study macro?
We cannot run experiments in macroeconomics, so we need to construct
models to be used as laboratories

Prague

A map of Prague

A map of Prague subway

How do we study macro?

A good model:


Simplified, abstract, representation of reality
Omits many details, represents only essential features needed to answer a specific question

 helpful to make predictions should be simple, but they need not be realistic.

2.1 Structure of a typical model
Households
Choose consumption, saving, labor supply
Firms
Choose production, investment, labor demand
Markets
Prices such that
Supply = demand

2.1 Structure of a typical model
1.
2.
3.
4.
Description of goods in the economy

Consumers preferences over goods

Firms technology available to produce the goods
The resources available

2.2 Prediction of a Model

Individual behavior

 people behave rationally (optimize) firms maximize profits

Equilibrium behavior
 competitive equilibrium

2.3 Microeconomic Foundations


1.
2.
The Approach
Start with consumers and firms making decisions at individual level
Aggregate them up
Representative Consumer Assumption
1.
Example: Benefits of this Approach
Monetary Policy

A Basic Intertemporal Model

A simple model where people choose how much to consume and how much to save





A) Consumer Optimization
B) Market Clearing
C) Adding capital stock
D) Welfare Theorems
E) Infinite horizon

A Basic Intertemporal Model


First period = current period
Second period = future period


To simplify, abstract from labor/leisure decision
Our interest: borrowing and saving by consumers

A Basic Intertemporal Model

Preferences of consumers
U ( c
1
)
 
U ( c
2
)


U ( c ) is increasing, differentiable and concave
Discount factor β <1 measures how much future utility matters relative to current utility

A Basic Intertemporal Model

Budget Constraints: c c
2
1
 b
1
 y
2
 y
1
 b
1
( 1
 r )


 y
1
, y
2 are exogenous incomes b
1 are savings from period 1 to period 2 r is the interest rate

Consumer’s optimization


Consumers maximize utility subject to budget constraints c
1 max
, c
2
, b
1
U ( c
1
)
 
U ( c
2
) s .
t c
1
 b
1
 c
2

Lagrangean y
1 y
2
 b
1
( 1
 r )
L ( c
1
, c
2
, b
1
,

1
,

2
)


 c
1 max
, c
2
, b
1
U ( c
1
)

1
(

2
( y
1 y
2
 
U

 c
1
 b
1
) b
1
( 1
 r )
( c
2
)
 c
2
)

Consumer’s optimization


First order conditions

U
U

( c
1

( c
2

1
)
)




1

2

2
( 1
 r )
Euler Equation
U

( c
1
)

( 1
 r )

U

( c
2
)

A) Consumer’s optimization

Log utility:

Solution: c
2 c
1

( 1
 r )
 c
1
*  y
1
1


1
 y
2
 r b
1
*  y
1
 c
1
*

Where are we?

A Basic Intertemporal Model

A) Consumer Optimization

B) Market Equilibrium

C) Adding capital stock

D) Welfare Theorems

E) Infinite horizon

B) Market Equilibrium


Suppose that there is
N identical agents
Market clearing condition is
Nb
1
*
( r
*
)

0

Log utility: y
1
 y
1
1


1
 y

2 r r
* 
1
 y
2 y
1