Universitat Pompeu Fabra

Barcelona GSE

Thijs van Rens

Spring 2012



Advanced Macroeconomics II (first half)

Business Cycle Fluctuations and Labor Markets






In this course, we study business cycles. In Advanced Macroeconomics I you studied models of economic growth (and you may study this topic in more detail in the topics course on Economic Growth in your second year). Here, we ask ourselves why and how the economy fluctuates around its growth path. In the first half of this course, we focus on the labor market, asking the question: why is the unemployment rate sometimes 2% and sometimes 12%? In this half, we consider only real models, i.e. models without money, in which business cycles are driven by technology shocks.


We discuss the two dominant classes of models. The real business cycle (RBC) model is basically the neoclassical growth model extended with a labor supply choice. If we interpret hours worked by the representative worker as a measure of aggregate employment, then we can use the model to describe fluctuations on the labor market. In search and matching models on the other hand, there is a continuum of workers and a continuum of firms. In these models, labor fluctuates along the extensive margin, i.e. the number of employed workers varies rather than the number of hours that each employee works. Neither model performs well at matching the data on business cycle fluctuations on the labor market, and we discuss various extensions that have been proposed to improve the models.


We conclude this half of the course by showing that, despite their very different interpretations, the RBC model and the search and matching model are remarkably similar in structure. We will also discuss some recent literature that tries to address the main shortcoming of both models: their failure to match the amplitude of fluctuations in (un)employment.


Course website (first half): www.thijsvanrens.com/macroII





Your grade for this half of the course will be based on weekly problem sets (20%) and a midterm exam (80%). The midterm will take place in the week of May 10 and will contain short answer questions as well as some longer problems. Your final course grade will be the simple average of your grades in the first and second halves of the course.


The weekly problem sets are meant to help you understand the material and prepare for the exam. There will be a problem set every week, posted on the course website after the Tuesday lecture and due at the beginning of class on Monday the week after. Solutions that are handed in late will not be graded. You are encouraged to do the problem sets in groups of 2 or –at most– 3 students. Please hand hand in one copy of the solutions for the group. However, I strongly recommend you not to divide up the problems, but rather to work on all problems together. It will be hard to do well on the exam without the practice you get from doing all problems.


Lien will discuss the problem sets in the practice session. No written solutions will be made available, so you should make sure to attend the practice sessions if you have problems solving the problem sets.



Reading List


I might update the reading list as we go along, so please check the course website for updates. Starred readings will be discussed in class. Non-starred readings are classics for background reading, recent articles on the topic or -in the case of textbooks- alternative readings. I will only briefly discuss these in class and you are therefore responsible for the global content but not for the details of these readings.



1. Real Business Cycle models


*David Romer (1996). Advanced Macroeconomics, 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.



2. Solving linear(ized) Rational Expectations models


*Roger E.A. Farmer (1999). Macroeconomics of Self-fulfilling Prophecies, chapters 1-3 and 5

*Fabio Canova (2007). Methods for Applied Macroeconomic Research, chapter 2 on DSGE Models, Solutions, and Approximations

Blanchard, O.J. and S. Fisher (1998), Lectures on Macroeconomics, sections 5.1, 5.2 and appendix to chapter 5 (with chapter 2 as a summary of things you should know already)

Maurice Obstfelt and Kenneth Rogoff (1996). Foundations of International Macroeconomics, supplements A and C to chapter 2

Ljungqvist, L. and T.J. Sargent (2000). Recursive Macroeconomic Theory, section 5.5 (with the rest of chapter 5 as background reading)

Marc Nerlove (1958). Adaptive Expectations and Cobweb Phenomena, Quarterly Journal of Economics, 72(2), pp. 227-240

John F. Muth (1961). Rational Expectations and the Theory of Price Movements, Econometrica, 29(3), pp. 315-335

Olivier Jean Blanchard; Charles M. Kahn (1980). The Solution of Linear Difference Models under Rational Expectations, Econometrica, 48(5), pp. 1305-1311

*John Y. Campbell (1994). Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model, Journal of Monetary Economics, 33, pp.463–506 (or NBER working paper No. 4188)

Christopher A. Sims (2000). Solving Linear Rational Expectations Models, lecture notes (programs)

Harald Uhlig (1995). A toolkit for analyzing nonlinear economic dynamic models easily, working paper (programs)




3. Business Cycles: Data and Facts


*Stock, James H. and Mark W. Watson (1999). Business Cycle Fluctuations in U.S. Macroeconomic Time Series. In: John B. Taylor and Michael Woodford (eds), Handbook of Macroeconomics, volume 1A, pp.3-64 (also NBER WP 6528)

Agresti, Anna-Maria, and Benoît Mojon (2001): "Some Stylized Facts on the Euro Area Business Cycle" in I. Angeloni, A. Kashyap, and B. Mojon eds., Monetary Policy Transmission in the Euro Area, Cambridge University Press. (also ECB WP #95)

Kydland, Finn, and Edward C. Prescott (1990): "Business Cycles: Real Facts and a Monetary Myth," Quartely Review, Federal Reserve Bank of Minneapolis

*Stock, James, and Mark W. Watson (2005): "Understanding Changes in International Business Cycle Dynamics" Journal of the European Economic Association, September 2005, v. 3, iss. 5, pp. 968-1006

Ramey, Garey, and Valerie A. Ramey (1995): "Cross-Country Evidence on the Link Between Productivity and Growth" American Economic Review, vol. 85, no. 5., 1138-1151

Backus, David K., Patrick J. Kehoe (1992): "International Evidence on the Historical Properties of Business Cycles," American Economic Review 82, 864-888.

Stock, James, and Mark W. Watson (2002): "Has the Business Cycle Changed and Why?," NBER Macroeconomics Annual 2002, MIT Press. (also NBER WP #9127)

*NBER business cycle dating committee



4. Empirical performance of the RBC model


*Jordi Gali (1999). Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations? American Economic Review, 89(1), pp. 249-271

*Jonas D. M. Fisher (2005). The Dynamic Effects of Neutral and Investment-Specific Technology Shocks, Working paper.

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

Rogerson, Richard (1988). Indivisible labor, lotteries and equilibrium. Journal of Monetary Economics, 21(1), pp.3-16.

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.



5. Search and Matching models


*Richard Rogerson, Robert Shimer and Randall Wright (2005). Search Theoretic Models of the Labor Market. Journal of Economic Literature, 43 (4): 959-988.

Christopher Pissarides (2000). Equilibrium Unemployment Theory, 2nd edition. Cambridge: MIT Press, chapters 1 and 2



6. Empirical performance of the search model


*Shimer (2006). Reassessing the Ins and Outs of Unemployment, mimeo, University of Chicago.

Shigeru Fujita and Garey Ramey (2006). The Cyclicality of Job Loss and Hiring, Philadelphia Fed Working Paper 06-17.

Shigeru Fujita and Garey Ramey (2007). Reassessing the Shimer Facts, Philadelphia Fed Working Paper 07-2.

Robert E. Hall (2005). Job Loss, job Finding, and Unemployment in the U.S. Economy over the Past Fifty Years, NBER Macro Annual.

Steve J. Davis (2005). Comments on “Job Loss, job Finding, and Unemployment in the U.S. Economy over the Past Fifty Years” by Robert E. Hall, NBER Macro Annual.

Jonathan L. Willis, Russell Cooper and John Haltiwanger (2007). Hours and Employment Implications of Search Frictions: Matching Aggregate and Establishment-Level Observations, Federal Reserve Bank of Kansas City Working Paper No. 06-14

*Robert Shimer (2005). The Cyclical Behavior of Equilibrium Unemployment and Vacancies, American Economic Review, 95(1): 25-49.

*Marcus Hagedorn and Iourii Manovskii (2008). The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited, American Economic Review, v. 98, iss. 4, pp. 1692-1706

Cole, Harold L. and Richard Rogerson (1999). Can the Mortensen-Pissarides Matching Model Match the Business-Cycle Facts? International Economic Review, 40(4), pp.933-959.



7. RBC models with search frictions


David Andolfatto (1996). Business Cycles and Labor-Market Search. American Economic Review, 86(1), pp.112-132

*Monika Merz (1995). Search in the Labor Market and the Real Business Cycle, Journal of Monetary Economics, 36, pp.269-300

Jordi Gali and Thijs van Rens (2010). The Vanishing Procyclicality of Labor Productivity.

Olivier Blanchard and Jordi Gali (2008). Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment, CREI working paper

Antonella Trigari and Mark Gertler (2006). Unemployment Fluctuations with Staggered Nash Wage Bargaining, forthcoming in the Journal of Political Economy


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