Harvard University John F. Kennedy School of Government Syllabus, Spring 2008 API 119: Advanced Macroeconomics for the Open Economy II

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1 Harvard University John F. Kennedy School of Government Syllabus, Spring 2008 API 119: Advanced Macroeconomics for the Open Economy II Professor Maurice Kugler Office Hours: Wednesday 2 4 at Rubenstein R 117 Assistant: Lauren Schiff (lauren_schiff@ksg.harvard.edu) Teaching Fellow: Alexander Culiuc (alexander_culiuc@ksgphd.harvard.edu) Overview This course is for students with a good background in micro theory, macro theory, econometrics, and mathematical techniques applied to economics. Our objective is to develop expertise in the use of models for the analysis of macroeconomic policy questions in open economies. The course relies on recent research with policy focus to build a substantive understanding of current issues in macroeconomics, as well as capability in applications of the core macroeconomic models. The rigor and discipline of mathematical models will give robust foundations to our analysis. Most importantly, our modeling will be oriented to have relevance, in that our analysis possesses potential impact upon policy change. Prerequisites Macroeconomic theory at the intermediate level; multivariate calculus and dynamic optimization (rudiments of control theory) are necessary. The course freely uses the techniques of dynamic optimization. As background reading I recommend Dynamic Optimization in Continuous Time Economic Models (A Guide for the Perplexed) by Maurice Obstfeld, ( You may also want to look at the math Appendix of R. Barro and X. Sala-i-Martin Economic Growth, second edition, Yet, if you are really perplexed you better start with Optimization in Economic Theory by Avinash Dixit. This course is open to non-mpa/id students by permission of the instructor only. Readings No single text covers all the material for the course. David Romer s Advanced Macroeconomics, third edition, 2006, (DR henceforth) is a book that has a nice coverage of recent research in macroeconomics, very much in the style of what Olivier Blanchard and Stanley Fischer Lectures on Macroeconomics, 1989, (BF henceforth) attempted a decade earlier. Because DR is the more up to date, we have selected this for background reading. In fact, given the large amount of material we expect you to read from this source, we have not included DR chapters in the package. As professional economists, you would be well advised to own a copy of both DR and the BF book. In lecture, we will be drawing mostly from these two plus, of course, a number of mostly classical articles in the field. Because this is a course to set up the stage for your understanding of macroeconomics, with a few exceptions I have chosen to direct you to seminal or survey articles in each topic relying on DR for a discussion of the developments thereafter. The reading list is short, under the assumption that you will skim through most of the pieces. Yet, there are two types of readings, some which you are required to read (flagged by *), and other pieces for background clarification.

2 For those interested in economic development at large, there are a couple of fairly recent books that constitute very stimulating complementary reading, and which provide a good link with material that is covered in lectures: Helpman, Elhanan (2004), The Mystery of Economic Growth, Harvard University Press. Rodrik, Dani (2007), One Economics, Many Recipes: Globalization, Institutions and Economic Growth, Princeton University Press. Grading Grading will be based on: a midterm (30%) problem sets (20%) a final (50%) The midterm will take place in class on March 11 and the final will be on May 21. Why do we do theory? This is a recurrent question in a course like this one, which attempts to address very practical issues with relatively abstract models. In a 1994 piece, The Rise and Fall of Development Economics, ( Paul Krugman argues that the utility of modeling, like that of mapmaking, stems from useful simplification. With their inimitable fiction, Argentinean writers A. Bioy Casares and J. L. Borges (under pseudonym B. Lynch Davis) illustrate in a story on maps the importance of the principle of parsimoniousness in Ockham s Razor ( ): "... In that empire, the art of cartography reached such perfection that the map of one province alone covered up the whole of a city, and the map of the empire, the whole of a province. In time, those unconscionable maps did not satisfy, and the colleges of cartographers set up a map of the empire which had the size of the empire itself and coincided with it point by point. Less addicted to the study of cartography, succeeding generations understood that this widespread map was useless and not without impiety they abandoned it to the inclemency of the sun and of the winters. In the deserts of the west some mangled ruins of the map lasted on, inhabited by animals and beggars; in the whole country there are no other relics of the disciplines of geography." Suarez Miranda, Viajes de varones prudentes, Book IV, Chapter XLV, Urida, A Universal History of Infamy, Penguin, London, 1975 The contribution of abstraction to analysis is the provision of tractable frameworks to characterize systems we aim to understand, leaving out those details, which are realistic but not essential to the subject being studied. Indeed, as Dani Rodrik remarks, in his highly recommended web log ( that abstract mathematical models possess the quality of aiding clear analysis with explicit linkages between premises and conclusions. Metaphors and intuition more often than not lack the precision needed in intellectual debate for policy formulation. 2

3 Course Contents The course will be focused on five main areas of the contemporary macroeconomics debate: (i) growth theory, (ii) overlapping generations models and social security, (iii) consumption and investment, (iv) business cycles (covering real business cycles and models of unemployment), and (v) a discussion of fiscal and monetary policy. I. Growth theory January 31 st and February 5 Introduction and the Solow model DR, Chapter 1. * Landes, D. (1990) Why are we so Rich and They so Poor?, American Economic Review, Vol. 80, May * Easterly, W. (2001) The Elusive Quest for Growth: Economists Adventures and Misadventures in the Tropics, Cambridge University Press, Chapter 2 and 3. Feb. 7 and 12 The Ramsey model and optimal savings in the closed economy DR. Chapter 2. Part A BF, Chapter 2. Subsections 1 3 Feb 14 and February 21 Endogenous growth models DR Chapter 3. Part A. * Romer P. (1989), Capital Accumulation in the Theory of Long-Run Growth, in Robert Barro, ed. Modern Business Cycle Theory, Harvard University Press. * Lucas, R. (1990) Why doesn t Capital Flow from Rich to Poor Countries American Economic Review, Vol. 80, No. 2, May. * Kremer, M. (1993) Population Growth and Technological Change One Million BC to 1990, Quarterly Journal of Economics, August. Feb 26 Path dependence, policy and economic growth * Krugman. P. (1987) The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Thatcher: Notes on Trade in the Presence of Dynamic Scale Economies, Journal of Development Economics, Vol. 27. * Lucas, R. (1993) Making a Miracle, Econometrica, Vol. 61 (2), pp

4 * Aghion, P. and P. Howitt (2005) Appropriate Growth Policy: A Unifying Framework, Mimeo Harvard University. Feb 28 Expectational indeterminacy, policy and economic growth * Diamond, P. (1982) Aggregate Demand Management in a Search Equilibrium, Journal of Political Economy, Vol. 90, No. 5. * K. Murphy, A. Shleifer and R. Vishny (1989), "Income Distribution, Market Size and Industrialization," Quarterly Journal of Economics, August. * K. Murphy, A. Shleifer and R. Vishny (1989), "Industrialization and the Big Push," Journal of Political Economy, October. Easterly, W. (2005) Reliving the 50s: the Big Push, Poverty Traps, and Takeoffs in Economic Development, No. 65. March 4 Convergence: Theory, evidence and econometric issues * Mankiw, G., D. Romer and D. Weil (1992) A Contribution to the Empirics of Economic Growth The Quarterly Journal of Economics, Vol. 107, No 2. * Sala-I-Martin X., (1997) I Just Ran Two Million Regressions The American Economic Review, Vol. 87, No. 2. * Caselli, F., G. Esquivel and F. Lefort (1996), Reopening the convergence debate: A new look at cross-country growth empirics, Journal of Economic Growth, Vol. 1, No. 3. March 6 Policies and Economic Growth * Hall, R. and C. Jones (1999) Why do Some Countries Produce so Much More Output per Worker than Others? The Quarterly Journal of Economics, February. * Rodrik, D. (2005) Why We Learn Nothing from Regressing Economic Growth on Policies, Mimeo, Kennedy School, March. Easterly, W. (2003), National Policies and Economic Growth: A Reappraisal, Center for Global Development, Working paper, Handbook of Economic Growth. End of Topics covered in Midterm Midterm date: March 11 4

5 II. Overlapping generation models March 13 The basic setup DR, Chapter 2. Part B. Diamond, P. (1965) National Debt in a Neoclassical Growth Model, American Economic Review, Vol. 55, 5, December, pp March 18 Social security and transitions BF, Chapter 3, subsection 1-2. * Feldstein, M. (1996) "The Missing Piece in Policy Analysis: Social Security Reform," The Richard T. Ely Lecture, in American Economic Review, Vol. 86, No. 2, May, pp * Feldstein, M (1997) Transition to a Fully Funded Pension System: Five Economic Issues NBER Working Paper, No March 20 and April 1 Consumption DR. Chapter 7. III. Consumption and investment April 3 Ramsey in open economy with investment DR Chapter 8 BF, Chapter 2.4 Sachs, J. (1981) The Current Account and Macroeconomic Adjustment in the 1970s, Brookings Papers on Economic Activity. Summers L. (1981) Taxation and Corporate Investment: A Q-Theory Approach Brookings Papers on Economic Activity. April 8 Real business cycles DR. Chapter 4. IV. Business cycles * Prescott, E. (1986) Theory Ahead of Business Cycle Measurement, Federal Reserve Bank of Minneapolis FED Quarterly. 5

6 April 10 and 15 Microeconomic foundations of rigidities: A primer DR Chapters 5 and 6 Friedman, M. (1968), On the role of Monetary Policy, American Economic Review, Vol. 58, No. 1. Lucas, R. (1976), Some International Evidence on Output-Inflation Tradeoffs The American Economic Review, Vol. 66, No. 5 Mankiw, G. and D. Romer (1991) Introduction in Mankiw G. and D. Romer (eds) New Keynesian Economics, Cambridge MIT Press. (this is just a long list of recent contributions that you can use as reference) Akerlof, G. (2002) Behavioral Macroeconomics and Macroeconomic Behavior, The American Economic Review, Vol. 92, No. 3, pp April 17 Ricardian equivalence DR. Chapter IV. Fiscal and Monetary Policy * Barro, R. (1974) Are Government Bonds New Wealth?, Journal of Political Economy, Vo. 82, No. 6. April 22 Tax smoothing and fiscal policy DR Chapter * Barro, R. (1979) On the determination of Public Debt, Journal of Political Economy, Vol. 87. * Alesina, A. and R. Perotti (1994) The Political Economy of Budget Deficits, IMF Staff Papers, Vol. 42. * Rodrik, D. "Why Do More Open Economies Have Bigger Governments?" Journal of Political Economy, 106(5), October April 24 and 29 Monetary policy: inflation and deficits DR, Ch

7 Cagan P. (1956) Monetary Dynamics of Hyperinflation in M. Friedman (ed.) Studies in the Quantity Theory of Money. Dornbusch, R., F. Sturzenegger, H. Wolf (1990) Extreme Inflation: Dynamics and Stabilization, Brookings Papers on Economic Activity, Vol. 2 BF Chapter 4. Sections 4.1, 4.2, 4.5 and 4.6 BF Chapter 8, Section 8.2 and Chapter 10, Section May 1 A discussion on monetary policy DR Chapter * Svensson, L. (1997) "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," European Economic Review, Vol. 41: * Mishkin, F. (2006) Monetary Policy Strategy: How did we get here? NBER Working Paper No , September. 7