Advanced Macroeconomics 2021 : an Easy Guide

Macroeconomic policy is one of the most important policy domains, and the tools of macroeconomics are among the most valuable for policy makers. Yet there has been, up to now, a wide gulf between the level at which macroeconomics is taught at the undergraduate level and the level at which it is practiced. At the same time, doctoral-level textbooks are usually not targeted at a policy audience, making advanced macroeconomics less accessible to current and aspiring practitioners. This book, born out of the Masters course the authors taught for many years at the Harvard Kennedy School, fills this gap. It introduces the tools of dynamic optimization in the context of economic growth, and then applies them to a wide range of policy questions – ranging from pensions, consumption, investment and finance, to the most recent developments in fiscal and monetary policy. It does so with the requisite rigor, but also with a light touch, and an unyielding focus on their application to policy-making, as befits the authors’ own practical experience. Advanced Macroeconomics: An Easy Guide is bound to become a great resource for graduate and advanced undergraduate students, and practitioners alike. Cover Title Page Copyright Page Dedication Page Short Contents Contents List of Figures List of Tables Preface Acknowledgments About the Authors Chapter 1. Introduction Note Growth Theory Chapter 2. Growth theory preliminaries 2.1 Why do we care about growth? 2.2 The Kaldor facts 2.3 The Solow model 2.3.1 The (neoclassical) production function 2.3.2 The law of motion of capital 2.3.3 Finding a balanced growth path 2.3.4 Transitional dynamics 2.3.5 Policy experiments 2.3.6 Dynamic inefficiency 2.3.7 Absolute and conditional convergence 2.4 Can the model account for income differentials? 2.5 The Solow model with exogenous technological change 2.6 What have we learned? Notes References Chapter 3. The neoclassical growth model 3.1 The Ramsey problem 3.1.1 The consumer's problem 3.1.2 The resource constraint 3.1.3 Solution to consumer's problem 3.1.4 The balanced growth path and the Euler equation 3.1.5 A digression on inequality: Is Piketty right? 3.1.6 Transitional dynamics 3.1.7 The effects of shocks 3.2 The equivalence with the decentralised equilibrium 3.2.1 Integrating the budget constraint 3.2.2 Back to our problem 3.3 Do we have growth after all? 3.4 What have we learned? Notes References Chapter 4. An application: The small open economy 4.1 Some basic macroeconomic identities 4.2 The Ramsey problem for a small open economy 4.2.1 A useful transformation 4.2.2 Solution to consumer's problem 4.2.3 Solving for the stock of domestic capital 4.2.4 The steady state consumption and current account 4.2.5 The inexistence of transitional dynamics 4.2.6 Productivity shocks and the current account 4.2.7 Sovereign wealth funds 4.3 What have we learned? 4.4 What next? Notes References Chapter 5. Endogenous growth models I: Escaping diminishing returns 5.1 The curse of diminishing returns 5.2 Introducing human capital 5.2.1 Laws of motion 5.2.2 Balanced growth path 5.2.3 Still looking for endogenous growth 5.3 The AK model 5.3.1 Solution to household's problem 5.3.2 At long last, a balanced growth path with growth 5.3.3 Closing the model: The TVC and the consumption function 5.3.4 The permanent effect of transitory shocks 5.3.5 In sum 5.4 Knowledge as a factor of production 5.4.1 Learning by doing 5.4.2 Adam Smith's benefits to specialisation 5.5 Increasing returns and poverty traps 5.5.1 Poverty trap in the Solow model 5.5.2 Policy options to overcome poverty traps 5.5.3 Do poverty traps exist in practice? 5.6 What have we learned? 5.7 What next? Notes References Chapter 6. Endogenous growth models II: Technological change 6.1 Modelling innovation as product specialisation 6.2 Modelling innovation in quality ladders 6.3 Policy implications 6.3.1 Distance to the technological frontier and innovation 6.3.2 Competition and innovation 6.3.3 Scale effects 6.4 The future of growth 6.5 What have we learned? 6.6 What next? Notes References Chapter 7. Proximate and fundamental causes of growth 7.1 The proximate causes of economic growth 7.1.1 Growth accounting 7.1.2 Using calibration to explain income differences 7.1.3 Growth regressions 7.1.4 Explaining cross-country income differences, again 7.1.5 Summing up 7.2 The fundamental causes of economic growth 7.2.1 Luck 7.2.2 Geography 7.2.3 Culture 7.2.4 Institutions 7.3 What have we learned? 7.4 What next? Notes References Overlapping Generations Models Chapter 8. Overlapping generations models 8.1 The Samuelson-Diamond model 8.1.1 The decentralized equilibrium 8.1.2 Goods and factor market equilibrium 8.1.3 The dynamics of the capital stock 8.1.4 A workable example 8.2 Optimality 8.2.1 The steady-state marginal product of capital 8.2.2 Why is there dynamic inefficiency? 8.2.3 Are actual economies dynamically inefficient? 8.2.4 Why is this important? 8.3 Overlapping generations in continuous time 8.3.1 The closed economy 8.3.2 A simple extension 8.3.3 Revisiting the current account in the open economy 8.4 What have we learned? Notes References Chapter 9. An application: Pension systems and transitions 9.1 Fully funded and pay-as-you-go systems 9.1.1 Fully funded pension system 9.1.2 Pay-as-you-go pension system 9.1.3 How do pensions affect the capital stock? 9.1.4 Pensions and welfare 9.2 Moving out of a pay-as-you-go system 9.2.1 Financing the transition with taxes on the young 9.2.2 Financing the transition by issuing debt 9.2.3 Discussion 9.2.4 Do people save enough? 9.3 What have we learned? 9.4 What next? Notes References Chapter 10. Unified growth theory 10.1 From Malthus to growth 10.1.1 The post-Malthusian regime 10.1.2 Sustained economic growth 10.2 A “unified” theory 10.2.1 A simple model of the demographic transition 10.2.2 Investing in human capital 10.2.3 The dynamics of technology, education and population 10.3 The full picture 10.4 What have we learned? 10.5 What next? Notes References Consumption and Investment Chapter 11. Consumption 11.1 Consumption without uncertainty 11.1.1 The consumer's problem 11.1.2 Solving for the time profile and level of consumption 11.2 The permanent income hypothesis 11.2.1 The case of constant labour income 11.2.2 The effects of non-constant labour income 11.3 The life-cycle hypothesis Notes References Chapter 12 Consumption under uncertainty and macro finance 12.1 Consumption with uncertainty 12.1.1 The random walk hypothesis 12.1.2 Testing the random walk hypothesis 12.1.3 The value function 12.1.4 Precautionary savings 12.2 New frontiers in consumption theory 12.2.1 Present bias 12.3 Macroeconomics and finance 12.3.1 The consumption-CAPM 12.3.2 Equity premium puzzle 12.4 What next? Notes References Chapter 13 Investment 13.1 Net present value and the WACC 13.1.1 Pindyck's option value critique 13.2 The adjustment cost model 13.2.1 Firm's problem 13.2.2 Tobin's q 13.2.3 The dynamics of investment 13.2.4 The role of x 13.3 Investment in the open economy 13.3.1 The consumer's problem 13.3.2 Bringing in the firm 13.3.3 Initial steady state 13.3.4 The surprising effects of productivity shocks 13.4 What next? Notes References Short Term Fluctuations Chapter 14. Real business cycles 14.1 The basic RBC model 14.1.1 The importance of labour supply 14.1.2 The indivisible labour solution 14.2 RBC model at work 14.2.1 Calibration: An example 14.2.2 Does it work? 14.3 Assessing the RBC contribution 14.4 What have we learned? 14.5 What next? Notes References Chapter 15 (New) Keynesian theories of fluctuations: A primer 15.1 Keynesianism 101: IS-LM 15.1.1 Classical version of the IS-LM model 15.1.2 The Keynesian version of the IS-LM model 15.1.3 An interpretation: The Fed 15.1.4 From IS-LM to AS-AD 15.2 Microfoundations of incomplete nominal adjustment 15.2.1 The Lucas island model 15.2.2 The model with perfect information 15.2.3 Lucas' supply curve 15.3 Imperfect competition and nominal and real rigidities 15.4 New Keynesian DSGE models 15.4.1 The canonical New Keynesian model 15.4.2 A Taylor rule in the canonical New Keynesian model 15.4.3 Back to discrete time 15.5 What have we learned? 15.6 What next? Notes References Chapter 16 Unemployment 16.1 Theories of unemployment 16.2 A model of job search 16.2.1 Introducing labour turnover 16.3 Diamond-Mortensen-Pissarides model 16.3.1 Nash bargaining 16.3.2 Unemployment over the cycle 16.4 Efficiency wages 16.4.1 Wages and effort: The Shapiro-Stiglitz model 16.5 Insider-outsider models of unemployment 16.5.1 Unemployment and rural-urban migration 16.6 What next? Notes References Monetary and Fiscal Policy Chapter 17. Fiscal policy I: Public debt and the effectiveness of fiscal policy 17.1 The government budget constraint 17.2 Ricardian equivalence 17.2.1 The effects of debt vs tax financing 17.2.2 Caveats to Ricardian equivalence 17.3 Effects of changes in government spending 17.3.1 The initial steady state 17.3.2 Permanent increase in government spending 17.3.3 Temporary increase in spending 17.4 Fiscal policy in a Keynesian world 17.4.1 The current (empirical) debate: Fiscal stimulus and fiscal adjustment 17.5 What have we learned? 17.6 What next? 17.7 Appendix 17.7.1 Debt sustainability 17.7.2 A simplified framework 17.8 Measurement issues 17.8.1 The role of inflation 17.8.2 Asset sales 17.8.3 Contingent liabilities 17.8.4 The balance sheet approach Notes References Chapter 18. Fiscal policy II: The long-run determinants of fiscal policy 18.1 Tax smoothing 18.1.1 The government objective function 18.1.2 Solving the government's problem 18.1.3 The time profile of tax distortions 18.1.4 The level of tax distortions 18.1.5 The steady state 18.1.6 Changes in government expenditures 18.1.7 Countercyclical fiscal policy 18.1.8 Smoothing government spending 18.1.9 Summing up 18.2 Other determinants of fiscal policy 18.2.1 The political economy approach 18.2.2 Fiscal rules and institutions 18.3 Optimal taxation of capital in the NGM 18.4 What have we learned? 18.5 What next? Notes References Chapter 19. Monetary policy: An introduction 19.1 The conundrum of money 19.1.1 Introducing money into the model 19.2 The Sidrauski model 19.2.1 Finding the rate of inflation 19.2.2 The optimal rate of inflation 19.2.3 Multiple equilibria in the Sidrauski model 19.2.4 Currency substitution 19.2.5 Superneutrality 19.3 The relation between fiscal and monetary policy 19.3.1 The inflation-tax Laffer curve 19.3.2 The inflation-tax and inflation dynamics 19.3.3 Unpleasant monetary arithmetic 19.3.4 Pleasant monetary arithmetic 19.4 The costs of inflation 19.4.1 The Tommasi model: Inflation and competition 19.4.2 Taking stock Notes References Chapter 20. Rules vs Discretion 20.1 A basic framework 20.1.1 Time inconsistency 20.1.2 A brief history of monetary policy 20.2 The emergence of inflation targeting 20.2.1 A rigid inflation rule 20.2.2 Which regime is better? 20.2.3 The argument for inflation targeting 20.2.4 In sum Notes References Chapter 21. Recent debates in monetary policy 21.1 The liquidity trap and the zero lower bound 21.2 Reserves and the central bank balance sheet 21.2.1 Introducing the financial sector 21.2.2 A model of quantitative easing 21.2.3 Effects of monetary policy shocks 21.3 Policy implications and extensions 21.3.1 Quantitative easing 21.3.2 Money and banking 21.3.3 Credit easing 21.4 Appendix Notes References Chapter 22. New developments in monetary and fiscal policy 22.1 Secular stagnation 22.2 The fiscal theory of the price level 22.2.1 Interest rate policy in the FTPL 22.3 Rational asset bubbles 22.3.1 The basic model 22.3.2 Government debt as a bubble 22.3.3 Implications for fiscal, financial and monetary policy 22.4 Appendix 1 22.5 Appendix 2 22.6 Appendix 3 Notes References Appendix A. Very brief mathematical appendix A.1 Dynamic optimisation in continuous time A.2 Dynamic optimisation in discrete time A.3 First-order differential equations A.3.1 Integrating factors A.3.2 Eigenvalues and dynamics Notes Appendix B. Simulating an RBC model Appendix C. Simulating a DSGE model Index "Macroeconomic policy is one of the most important policy domains, and the tools of macroeconomics are among the most valuable for policy makers. Yet there has been, up to now, a wide gulf between the level at which macroeconomics is taught at the undergraduate level and the level at which it is practiced. At the same time, doctoral-level textbooks are usually not targeted at a policy audience, making advanced macroeconomics less accessible to current and aspiring practitioners. This book, born out of the Masters course the authors taught for many years at the Harvard Kennedy School, fills this gap. It introduces the tools of dynamic optimization in the context of economic growth, and then applies them to a wide range of policy questions 0́3 ranging from pensions, consumption, investment and finance, to the most recent developments in fiscal and monetary policy. It does so with the requisite rigor, but also with a light touch, and an unyielding focus on their application to policy-making, as befits the authors0́9 own practical experience"-- Provided by publisher