Econ 3101
Advanced Macroeconomics
Dr. Victor Li
Spring 2010
• Textbooks:
Primary: Williamson - Macroeconomics
Others: Romer, McCallum, Lecture Notes
Remark about integrating readings.
• Prerequisits:
Economics – 1001,1002, 2101,2102
Math – Algebra, Multi-Variable Calculus,
Linear Algebra (1500, 1505, 3400)
Math Econ - 3128
• You need to be familiar AND comfortable with this level
of mathematics to do well in the course.
• Grades
• Website: www.homepage.villanova.edu/victor.li
• Objective: To provide an introduction to modern
methods used in macroeconomic research.
* Revisit static IS-LM macro model
* Integration of macro with micro economics
* Study the dynamic process of business
cycles, economic growth, and stabilization
policy.
Some Macro Facts and Issues
• Key Measures of Macroeconomic activity:
(1) GDP (level and per capita)
(2) Productivity
(3) Prices and Inflation
U.S. Output, 1869-2005
Figure 1.1 Per Capita Real GDP (in 2000
dollars) for the United States, 1900–2005
GDP Growth: 1970-2008
Macroeconomic Data and Growth
Rates
• Data collected over time is often referred to as time series
data. Most macro data is time series.
• Let yt = an economic variable recorded at date t
• The growth rate of y from date (t-1) to (t) is given by
gt 
yt  yt 1 y
y

 t 1
yt 1
y
yt 1
• If g is a small number (even 5% is 0.05), then
ln( 1  g )  g
• Using this, we have
gt  ln( yt )  ln( yt 1 )   ln( y)
• Example
Year
2000
2001
2002
GDP
10
10.25
10.50
g =y/y
g=ln(y)
2.5%
2.44%
2.46%
2.40%
Figure 1.1 Per Capita Real GDP (in 2000
dollars) for the United States, 1900–2005
Figure 1.2 Natural Logarithm of Per
Capita Real GNP
• GDP movement can be divided into two
parts: trend and cyclical.
• Trend GDP and productivity growth
measures long-term economic growth.
Annual Productivity Growth
1955-73
2.12%
1973-98
1.67%
What determines long-term growth and what
are the implications for policy?
Figure 1.2 Natural Logarithm of Per
Capita Real GNP
Figure 1.3 Natural Logarithm of Per
Capita Real GNP and Trend
Figure 1.4 Percentage Deviations from
Trend in Per Capita Real GNP
Figure 1.10 Percentage Deviations from
Trend in GDP, 1947–2003
• Cyclical (detrended GDP) measures the
business cycle.
(i) Largest recession was GD.
(ii) Wartimes are usually associated with
expansion. 1991-01 was longest peace time
expansion.
(iii) Historical observations:
- Okun’s Law
- Phillip’s Curve
(iv) Business cycles are similar in terms of comovement and timing.
Questions: What causes business cycles and
what’s the role of government stabilization
policy? What explains short-run versus long-run
tradeoff between inflation and unemployment?
Macro Economic Theory
• Y = set of macroeconomic variables (facts)
(needs measurement)
X = set of given variables, assumptions about
how economy works.
• Construction of theory:
X

Y
• Validation of Theory
Ability to explain facts (statistical)
Theories need not be completely correct to
be useful!
Economics as Social Science
• Difference between hard-sciences and
social science is the lack of natural or
controlled experiments.
• Models can be used to design artificial
economies or economic laboratories.
The Evolution of Macro Ideas
• “A Quick Refresher Course in Macroeconomics”
by N. Gregory Mankiw, Journal of Economic
Literature (Dec 1990).
• “Revolution and Evolution in 20th Century
Macroeconomics” by Michael Woodford,
Princeton, 1999.
• Gap between “applied” and “modern” macro
theory.
Applied  IS-LM, Phillips Curve
Used in textbooks, forecasters,
public policy making.
Modern  Developments in macro research
(“academic”) of the past 30-40 years.
• At some level, gap is also caused by the degree
of complexity and rigor of models and the tools
of analysis.
• Copernicus (heilocentric) versus Ptolemy
(geocentric)
- Ultimately modern developments will change
the way macroeconomists view the world and
economic policy is conducted.
• Market Economics (Classical - 18th, 19th
Centuries)
- Adam Smith, David Ricardo
- Free market adjustment of prices
- Classical Dichotomy
- Invisible hand, government nonintervention
• Keynesian Revolution (1930s)
- “Birth” of Macroeconomics
- J.M Keynes, P. Samuelson, J. Tobin
- Great Depression
- Failure of Markets and price system
- Need for active stabilization policy
- Development of basic IS-LM model and
amended to include Phillips Curve
(The “consensus” or “neoclassical
synthesis” from 1930-70)
• 1970s: Breakdown of the consensus.
- Empirical:
Failure to account for high
inflation and unemployment
(Philips Curve breakdown).
- Theoretical: Gap between macro and
microeconomic principles.
Fails to account for how
expectations affects behavior
(the “Lucas Critique”)
IS-LM model is, at best, incomplete.
• Monetarism & New Classical Macroeconomics
- M. Friedman , R. Lucas, T. Sargent, N.
Wallace, R. Barro.
- Economic decisions are dynamic.
- Rational expectations
- Microeconomic foundations & MarketClearing
- Intertemporal General Equilibrium Macro
Models (“Modern Macro Models”)
• Microfoundations? Another parable of
Friedman and the billiard player.
• New Classical Theories
- imperfect information and money
- real business cycles
- Sectoral shifts (search unemployment)
• New Keynesian Macroeconomics
- L. Ball, G. Mankiw, D. Romer.
- Also incorporates dynamic decision
making and rational expectations.
- Microeconomic foundations of sticky
wages and prices (labor contracts,
monopolistic competition).
• New Neoclassical Synthesis (1990sPresent)?
* Integration of Keynesian and Classical
ideas into modern macro models.
* Market Clearing “Keynesian” Models
(e.g., coordination failure)
* Emphasis on both real and nominal
shocks.
Relation to Eco 2101
• Used IS-LM model to explain both Classical
& Keynesian Theories by distinguishing
between short-run and long-run.
• IS-LM as an analytical tool is at best
incomplete.
* Micro-foundations for individual behavior
* Static versus dynamic
* No explicit treatment of expectations
• Objective of this course: Develop the
foundations of modern macro theory and
apply them to studying growth, business
cycles, and economic policy.
• New Classical macro models will be
emphasized:
* Benchmark model
* Led to the development of modern
macro theory.
• Things you should know about measurement
- Definition and measurement of basic concepts:
GDP, GNP prices, interest rates, budget
deficit, unemployment rate, ect.
- Real versus nominal and the price index as a
deflator.
- Measurement of saving and wealth and
relationship to investment.
Math Review
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Functions and Differentiation
Matrices
Systems of Equations
Unconstrained Optimization
Constrained Optimization
Others