ECON 3040 Intermediate Macroeconomic Theory

Prof. Mathieu Taschereau-DumouchelSpring 2018

ECON 3040Intermediate Macroeconomic Theory

Lecture 1: Introduction and overview

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Outline• What is macroeconomics?• Course overview and administrative stuff• A first look at the data

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What is macroeconomics?• Microeconomics: study the decision of individual economic

agents (consumers, firms, etc)• Macroeconomics: study the economy as a whole.

• Typical macro questions1. Output: Why are some countries much richer than others?

Why are some workers unable to find work? Why do we have recessions?

2. Inflation: What determines the growth rate of prices?3. Budget deficits: Why do governments borrow? Why do some

default? Can government policies influence the economy?4. Financial crises: What causes financial crises? Can policy help?

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Why is Macro important?• Policies affect the welfare of billions of people– Poorly designed interventions in the past created

massive unemployment• (too) many examples…

• Many business decisions revolve around the overall state of the domestic and world economy– The financial crisis of 2007-2009 is a great example– Many people were affected by the crisis even though

they have little direct connection to real estate, banking or insurance

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Variation in U.S. Corporate Profits Due to Macro Shocks 1962-2009 (Goldman Sachs)

Industry Percentage

Aircraft 16%

Autos 59%

Department Stores 67%

Food 20%

Health Services 35%

Oil 62%

Steel 53%

US Average 44%

Objectives and approach• Our objectives– Provide a coherent model of the aggregate

economy.– Use it to understand economic events and policies

• Our approach– Document the facts– Develop a model– Test the model: does it account for the facts?– Use the model

• Evaluate the effectiveness of policies• Make forecasts

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What is a model?• The world economy is incredibly complex (just

think about it for a second…)

• An economic model– is a simplified description of the world– it abstracts from many things to highlight the essential

mechanisms– formalizes our common sense– is written in the language of mathematics– gives unambiguous answers to question

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Our modelling approach• Consider economy as a combination of different markets• Build analysis from the bottom up

– Individual: derive demand and supply from agents’ (households, firms) optimal decision problems

– Aggregate: sum up demands and supplies across agents and combine to describe goods, labor and capital markets

– General equilibrium: combine different aggregates such that all markets clear simultaneously

• Advantages– Changes in economic environment (e.g. taxes) change agents’ behavior

=> bottom up analysis allows us to take these changes into account– Markets are interrelated and must be considered jointly

=> General equilibrium allows us to do so

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Course program

• Review macro data

• Describe key economic markets

– Production and labor market

– Consumption, investment and capital markets

– Money, prices and asset markets

• Combine everything in general equilibrium

– IS-LM / AS-AD framework

• Use model to discuss

– Business cycles (Classical vs. Keynesian view)

• Fiscal and monetary policy

– Long-run growth

• Expand model to address issues in international economics

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Lectures• Feel free to ask questions often and at any

time

• Please don’t distract your classmates (and yourself)– No cell phones– Laptops & iPads only for note-taking

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Website• (almost) everything is on Piazza:

https://piazza.com/cornell/spring2018/econ3040/home–Make sure you are subscribed to the

announcements!• Grades are on blackboard

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Piazza• Main online discussion tool for this class• First place to go if you have questions about

the material– The teaching staff will frequently answer

questions there– Fellow students are encouraged to answer

questions as well!

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Required material• Lecture notes (slides)– Available on Piazza (usually the evening before

class)

• Textbook– Abel, Bernanke and Croushore (2013).

Macroeconomics. Addison-Wesley, 9th edition (8th

or 7th editions are close). [ABC]– Also available in loose-leaf format

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Grading• Exams (80%)–Midterm 1: Wednesday, February 28th

–Midterm 2: Wednesday, March 28th

– Final: Monday May 21st (subject to change)• Problem sets (20%)

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Exams• Format

– Comprehensive but focus on new material– Closed-book except for one 8.5’’ x 11’’ sheet of

handwritten notes for the first prelim, two sheets for the second prelim and three sheets for the final. You can write on both sides of the sheets (see syllabus for details).

– Bring a calculator• Computation of total exam grade

– Final exam counts double the weight of a midterm exam -> 4 exam grades

– Total exam grade = average of 3 best out of 4 grades -> Insurance policy!-> No make-up exam

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Problem sets• Objective– Reinforce key concepts from class and prepare for

exams• Details– You can work in group but actively working on

problem sets is essential for your understanding of the material

– One submission per person– Submission: beginning of lecture– No online submission

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Office hours• Professor– Monday: 4pm – 5pm– By appointment (email: mathtd@cornell.edu)– Office: Uris 480

• TAs– Tilahun Emiru: tme29@cornell.edu

• OH: Monday 10am to 12pm, • Uris 465

– Malin Hu: mh975@cornell.edu• OH: Wednesday 10am to 11am and Thursday 9am to 10am• Uris 453

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A first look at the data• Long-run growth• Business cycle fluctuations• How bad was the most recent recession?

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Two Main Focuses• Economic growth–Most economies experience substantial growth

over long horizons – Somewhat easier to understand and predict

• Business cycles– Short term fluctuations around long run trends– Bulk of the attention by newspapers and policy

makers– They are also harder to understand

Output in the United States

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US output per capita

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1820 1840 1860 1880 1900 1920 1940 1960 1980 20000

0.5

1

1.5

2

2.5

x 104 US per capita GDP

year

dolla

rs o

f 200

0

Using logs to get growth rates• x(t) = some variable of interest in period t• g(t) = growth rate between t-1 and t

• A good approximation when g is small:

• So:

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g(t) = x(t)− x(t −1)x(t −1)

log(1 + g(t)) ⇡ g(t)

g(t) ⇡ log(1 + g(t))

= log

✓1 +

x(t)� x(t� 1)

x(t� 1)

◆= log

✓x(t)

x(t� 1)

◆

= log(x(t))� log(x(t� 1))

Using logs to get growth rates• Recall:

• So what? – If we plot log(x(t)) and we get a line, the growth

rate is constant!– The slope of the line is the growth rate:

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g(t) ⇡ log(x(t))� log(x(t� 1))

slope =log(x(t))� log(x(t� 1))

t� (t� 1)= log(x(t))� log(x(t� 1)) = g(t)

US output per capita in logs

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1820 1840 1860 1880 1900 1920 1940 1960 1980 20006

6.5

7

7.5

8

8.5

9

9.5

10

log of US per capita GDP

year

log

dolla

rs o

f 200

0

Notice: the trend (long-run growth) and the fluctuations (business cycle)

The US growth experience

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Period Real GDP Real GDP per capita

1929-1948 2.54% 1.50%1948-1973 3.70% 2.22%1973-1982 1.55% 0.49%1982-2006 3.60% 2.60%1929-2006 3.10% 1.91%

Some countries catch up…

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… while others don’t(1 log point = 2.72 times richer)

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The miracle of compounding• “Compound interest is the most powerful force in the universe”

– Albert Einstein (maybe)

• Small differences in average growth rates create huge differences in output per capita

• Example: output per capita growth 1820-1950– North-America:

• 1.58% per year => (1.0158)130 = 7.67

– Western Europe:• 1.06% per year => (1.0106)130 = 3.94

– Rest of the world:• 0.50% per year => (1.0050)130 = 1.91

» (source: Maddison, WSJ, Jan 11, 1999)

• What is the source of long-run growth?• Why are some countries growing faster than others?

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Money isn’t everything…

29Source: https://ourworldindata.org/happiness-and-life-satisfactionBackground reading: ‘Happiness: A measure of cheer’. Financial Times (12/27/2010)

Business cycles: definition• Fluctuations in aggregate economic activity

– GDP, employment, trade, financial markets

• Recurrent expansions and contractions– Deviations from long run growth

• Persistent but of variable length (i.e. not periodic)– Fluctuations between 1.5 to 8 years

• Recession – Decline in output, employment, investment and trade.– Simple definition: 2 consecutive quarters of negative output

growth

• Depression– Very large recession (definitions vary)

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NBER business cycles

Industrial production

Unemployment rate

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ECON-UA 12 Intermediate Macro - Introduction 16

Business Cycles

Some fluctuations very large (Great Depression: 25% drop in output, current recession : unemployment jumped from 5% to 10%)

What is the source of business cycles?

• What generates business cycles? Is it a big deal?• Why is there unemployment?

The most recent recession

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Investment

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The unemployment rate has recovered…

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… but not employment

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Stock marketInflation adjusted

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Fiscal policy: government debt exploded

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Monetary policy

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Inequalities are exploding

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• Web: http://wid.world/country/usa/• Inequalities and Cornell– https://www.nytimes.com/interactive/projects/co

llege-mobility/cornell-university

Summary• Things move together: goods, labor and

capital markets are interrelated and must be analyzed together in general equilibrium

• We commonly decompose macro time series into long-run growth and business cycle components

• The most recent recession was really bad

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