Thijs van Rens

Universitat Pompeu Fabra

Graduate Program in Economics

Macroeconomics I

Part 2: Investment, consumption and employment

Fall 2006

Course objectives

In the first half of this course you studied the neo-classical growth model, which describes the long run determinants of GDP. In this half, we focus on the behavior of two main components of GDP: consumption and investment. We will also have a closer look at macroeconomic fluctuations on the labor market. Over five weeks, we will study several different models. The focus is on understanding how these models work and what we can learn from them, but also on how well they describe (features of) the real world. Within each topic, we will approximately follow the historical evolution of our thinking and motivate each step by evaluating the empirical performance of the models.

    While the emphasis is on economic content, an important second objective is to familiarize you with the most important techniques that are commonly used in modern macroeconomics. A firm’s decision how much of its revenues to invest in capital accumulation and a consumer’s choice how much of her income to save are two examples of intertemporal optimization problems. When studying investment, we will primarily consider deterministic optimization problems, or models in which agents have perfect foresight, and use optimal control theory (Lagrangians) to solve these models. But many real-world problems cannot be understood in a deterministic setting. Therefore, when we study consumption, we will introduce uncertainty in the model, so that agents have to form expectations about the future. We will also use a different method to solve intertemporal optimization problems (dynamic programming, Bellman equation).

    This course targets primarily future PhD students and aims to prepare you to produce rather than simply consume research. Unless you have a strong background in the material that we cover, you will find that this is a hard course that requires a lot of work. In particular, it will be impossible to earn a good grade without spending many hours a week solving problem sets that will at times be quite technical. If you are mainly interested at a more intuitive introduction to macroeconomics (and do not plan to do a Ph.D.), it is recommended that you take the parallel course in "Applied Macroeconomics".

Administrative issues

Problem sets: There will be four problem sets, posted on the course website after the second lecture of each week and due in the first lecture the week after. The TA will grade your work and discuss the solutions in the practice session. The problem sets will will test your understanding of the material covered in class, but will also extend that material and require you to solve problems you have not seen before. I encourage you to cooperate on these problems with your classmates in small groups (2 or 3 students). You may hand in one copy of the solutions for the group.

Grading: Your grade for this half of macroeconomics I will be determined by the questions about investment and consumption on the final exam (75%) and your average performance on the problem sets (25%). Problem sets handed in late will be awarded zero points. I may also give a short quiz in the practice session of the second week, which would count for a small percentage of the grade. Your final grade for the whole course will be the average of your grade in each half.

Lectures: Thursdays 11:00 - 13:00 in room 20.051, Fridays 16:00 - 18:00 in room 20.053 (starting from November 2).

Office hours: time TBA, room 20.1E32

Teaching Assistant: Maria Guecheva, maria.guecheva@upf.edu

If you want to talk to me about the problem sets, please come to office hour. For any other questions you are welcome to come to office hour or you can email me at thijs.vanrens@upf.edu to set up an appointment. This syllabus, the problem sets and other relevant information will be posted on the course website: http://www.crei.cat/~vanrens/macroI.

Reading List

Most of the material taught in this course is covered in the main textbooks in macroeconomics. For investment and RBC, I will primarily follow Romer (the same book you used in the first half). For consumption, I do not follow any single book closely, but many of the lectures are based on Deaton (1992) or Adda and Cooper (2003). A detailed reading list is provided below. Starred textbook readings cover more or less what we do in class, non-starred textbooks are alternatives but might be less close to the lecture. Starred articles will be discussed in class. Non-starred articles are treated in the textbook or provide further reading. I will update the readinglist as we go along, so please check back once in a while.

1. Investment

*Romer (1996), chapter 8

Robert E. Lucas, Jr (1967). Optimal Investment Policy and the Flexible Accelerator, International Economic Review, 8(1), pp. 78-85.

James Tobin (1969). A General Equilibrium Approach To Monetary Theory, Journal of Money, Credit and Banking, 1(1), pp.15-29.

*Fumio Hayashi (1982). Tobin's Marginal q and Average q: A Neoclassical Interpretation, Econometrica, 50(1), pp.213-224.

Lawrence H. Summers (1981). Taxation and Corporate Investment: A q-Theory Approach, Brookings Papers on Economic Activity, 1981(1), pp. 67-140 (with comments by Barry P. Bosworth, James Tobin and Philip M. White)

Andrew B. Abel and Olivier J. Blanchard (1986). The Present Value of Profits and Cyclical Movements in Investment, Econometrica, 54(2), pp. 249-274.

Mark E. Doms and Timothy Dunne (1998). Capital Adjustment Patterns in Manufacturing Plants, Review of Economic Dynamics, 1(2), pp. 409-429

Avinash K. Dixit and Robert S. Pindyck (1994). Investment under uncertainty, Princeton University Press.

Guiseppe Bertola and Ricardo J. Caballero (1994). Irreversibility and Aggregate Investment, Review of Economic Studies, 61(2), pp.223-246.

2. Consumption: the intertemporal savings decision under uncertainty

a) The canonical consumption model

*Adda and Cooper (2003), sections 6.1 - 6.2.2 and 6.3 - 6.3.2

*Deaton (1992), section 3.1

Deaton (1992), chapters 1 and 2

Blanchard and Fisher, section 6.2 and 3.4

Romer (1996), sections 7.1, 7.2 and 7.4

Milton Friedman (1957). A Theory of the Consumption Function.

Franco Modigliani (1986). Life Cycle, Individual Thrift, and the Wealth of Nations, American Economic Review, 76(3), pp.297-313.

Robert J. Barro (1979). On the Determination of the Public Debt, Journal of Political Economy, 87(5), pp. 940-971.

b) Dynamic programming

*Adda and Cooper (2003), chapter 2

Stokey and Lucas (1989), chapters 1, 2, 4 and 9

Ljungqvist and Sargent (2004), chapter 3

3. Empirical performance of the Life-Cycle / Permanent Income Hypothesis

*Deaton (1992), chapters 3.2 - 4

Romer (1996), section 7.3

Robert E. Hall (1978). Stochastic Implications of the Life-Cycle Permanent-Income Hypothesis, Journal of Political Economy, 86(6)

Orazio Attanasio (1999). Consumption, chapter 11 in John B. Taylor and Michael Woodford (eds), Handbook of Macroeconomics, volume 1B (or NBER Working Paper 6466), sections 1 - 3.3

Marjorie A. Flavin (1981). The Adjustment of Consumption to Changing Expectations About Future Income, Journal of Political Economy, 89(5), pp.974-1009.

4. Asset pricing, consumption CAPM and the equity premium puzzle

*Adda and Cooper (2003), sections 6.2.3 and 6.3.3

Bagliano and Bertola (2004), section 1.4

Romer (1996), section 7.5

Blanchard and Fisher (1989), section 6.2 (p.279-288)

Paul Samuelson (1969). Lifetime Portfolio Selection by Dynamic Stochastic Programming, Review of Economics and Statistics, 21, pp.239-246.

Robert C. Merton (1969). Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case, Review of Economics and Statistics, 3, pp. 247-57.

Rajnish Mehra and Edward C. Prescott (1985). The Equity Premium: A Puzzle, Journal of Monetary Economics, 15, pp.145-162.

Rajnish Mehra and Edward C. Prescott (2003) The Equity Premium in Retrospect, NBER Working Paper No. 9525.

Lars Peter Hansen and Kenneth J. Singleton (1982). Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models, Econometrica, 50(5), pp. 1269-1286. Errata (1984).

Lars Hansen and Ravi Jagannathan (1991). Implications of Security Market Data for Models of Dynamic Economies, Journal of Political Economy, 99, pp.225-262.

John Cochrane and Lars Hansen (1992). Asset Pricing Explorations for Macroeconomists, NBER Macroeconomics Annual, edited by Olivier Jean Blanchard and Stanley Fischer, pp.115-182.

5. Real Business Cycles: labor market fluctuations

*Romer (1996), chapter 4

Kydland, Finn E. and Edward C. Prescott (1982). Time to Build and Aggregate Fluctuations. Econometrica, 50(6), pp.1345-1370.

*King, Robert G. and Sergio T. Rebelo (1999). Resuscitating Real Business Cycles. In: John B. Taylor and Michael Woodford (eds), Handbook of Macroeconomics, volume 1B, pp.927-1007.

Backus, David K., Patrick J. Kehoe and Finn E. Kydland (1995). International Business Cycles: Theory and Evidence. In: Thomas F. Cooley (ed), Frontiers of Business Cycle Research, chapter 11.

*Hall, Robert E. (1997). Macroeconomic Fluctuations and the Allocation of Time. Journal of Labor Economics, 15(1), pp.S223-S250.

Hansen, Gary D. (1985). Indivisible Labor and the Business Cycle. Journal of Monetary Economics, 16(3), pp.309-327.

Benhabib, Jess, Richard Rogerson and Randall Wright (1991). Homework in Macroeconomics: Household Production and Aggregate Fluctuations. Journal of Political Economy, 99(6), pp.1166-1187.

Textbooks:

Adda, J. and R. Cooper, Dynamic Economics, MIT Press, 2003

Bagliano, F.-C. and G. Bertola, Models for Dynamic Macroeconomics, Oxford University Press, 2004

Barro, R.J. and X. Sala-i-Martin, Economic Growth, McGraw Hill, 1995

Blanchard, O.J. and S. Fisher, Lectures on Macroeconomics, MIT Press, 1998

Deaton, A., Understanding Consumption, Clarendon Press, 1992

Ljungqvist, L. and T.J. Sargent, Recursive Macroeconomic Theory, MIT Press, 2000

Romer, D., Advanced Macroeconomics, McGraw Hill 1996, or a later edition

Stokey, N.L. and R.E. Lucas, with E.C. Prescott, Recursive Methods in Economic Dynamics, Harvard University Press, 1989