Dynamic Macroeconomics - Introduction · Bachelor versus master level macro education: Bachelorvs. masterlevelmacroeducation: Analysisofthe eﬀectofanaggregatedemandshock. Bachelorlevelanalysis

Dynamic MacroeconomicsIntroduction

University of Siegen

University of Siegen Dynamic Macroeconomics 1 / 20

Overview

1 Bachelor versus master level macro education:

2 Organizational issuesContact informationCourse information


Bachelor versus master level macro education:


• What is the value-added of the course Dynamic Macroeconomics?• Question is answered based on three illustrations of the value-addedof this course relative to a standard bachelor macro course.

• Analysis of the effect of an aggregate demand shock (short-runanalysis).

• Analysis of the effect of a one-time increase in the saving rate(long-run analysis).

• Decomposition of macroeconomic time series (business cycle versusgrowth perspective).

=⇒ Ultimate goal: Learn tools that enable you to performindependent economic analysis.

=⇒ By-product: Improve your analytical skills.



Bachelor versus master level macro education: Analysis ofthe effect of an aggregate demand shock (business cycleanalysis).

• Bachelor level analysis:• Consider a closed economy with households, firms, fiscal and a

monetary authority.• Question: What is the effect of a positive aggregate demand shock?

Cha

pter

9:

Infla

tion,

Act

ivity

, and

Nom

inal

Mon

ey G

row

th

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Macroeconomics, 5/e • Olivier Blanchard 14 of 30

9-2 The Effects of Money Growth

Output Growth, Unemployment, Inflation, and Nominal Money Growth

Figure 9 - 2



Bachelor versus master level macro education: Analysis ofthe effect of an aggregate demand shock (business cycleanalysis).

• Bachelor level analysis:• Consider a closed economy with households, firms, fiscal and a

monetary authority.• Aggregate demand, YD , is given by:

YD = C + I (r ) + G . (1)• There is an aggregate demand shock:

• Can be unexpected increase in either C , I or G .• Denoted by εD .• Aggregate demand is then given by:

Y D = C + I (r ) + G + εD . (2)

• Question: What is the effect of a positive aggregate demand shock?University of Siegen Dynamic Macroeconomics 5 / 20


Bachelor vs. master level macro education: Analysis of theeffect of an aggregate demand shock.

• Bachelor level analysis (continued):• Combination of Phillips curve:

π = πe − α (u − un) (3)

with Okun’s law (negative relationship between unemployment andoutput growth) yields:

π = πe + β (Y − Y n) (4)

• Positive demand shock εD > 0 =⇒ YD ↑ =⇒ YD − Y n ↑ =⇒Phillips curve: π = πe + β (Y − Y n) =⇒ π ↑ =⇒ Monetaryauthority: r ↑ =⇒ YD ↓.




• Bachelor level analysis (continued):• Overall results:

• At first, positive demand shock leads to higher output and inflation.• Monetary authority then increases interest rates.• The increase in interest rates dampens demand and as a consequence

inflation rates decrease.• Finally, the economy returns to its natural output level at which

inflation is equal to its target.• Assessment of bachelor-level-analysis:

• Provides a good understanding of basic macroeconomic processesinduced by a demand shock.

• However, there exist some unsatisfying shortcomings:• Provides a qualitative, but no quantitative analysis.• Does not provide an appropriate framework to analyze the dynamics

from the old to the new equilibrium.• Does not explain the structural parameters of the economy.




• Master level analysis:• Goal: Develop an analytical framework that allows us to overcome the

shortcomings of the bachelor level macro framework.• Guideline for master level macro approach is provided by sentence of

Frank Fisher:

“Macroeconomics is microeconomics. Plus aggregation”.

• Focus: Microeconomics. Aggregation problems are assumed away.• Basic approach:

• Model household, firm and government behavior explicitly.• Solve their decisions problems.• Determine equilibrium in goods and factor markets.• Evaluate model solution.




• Master level analysis:• Model setup:

• Household experience utility from consuming and supply labor(Objective: Maximize lifetime utility).

• Firms have access to a production function and use labor to produceoutput (Objective: Maximize profits).

• Monetary authority controls short-term nominal (and due to pricerigidities real) interest rates. Objective: Minimize loss function, L:

L = (π − π∗) + ω (y − yn) (5)

with π∗ = 0 and ω = 0.5 (flexible inflation targeting).

• Scenario: There is a one-time demand shock of size 1.




• Master level analysis:

2 4 6 8 10 12 14 16 18 200

0.5

1π

Time

2 4 6 8 10 12 14 16 18 20−0.5

0

0.5

1

1.5y−y*

Time

2 4 6 8 10 12 14 16 18 200

0.5

1

1.5

2i

Time




• Master level analysis: ω = 0 (strict inflation targeting)

2 4 6 8 10 12 14 16 18 200

0.5

1π

Time

2 4 6 8 10 12 14 16 18 20−1

−0.5

0

0.5

1y−y*

Time

2 4 6 8 10 12 14 16 18 200

1

2

3i

Time



Bachelor vs. master level macro education: Analysis of anone-time increase in the saving rate (long-run analysis).

• Bachelor level analysis:• The economy is described by the following aggregate production

function:Y = K α (AL)1−α . (6)

• Model solution: Express variables in terms of units of efficient laborand solve for steady-state. Result:

k∗ =( s

δ

)α(7)

• Now assume that s increases once.• Effect: There is a new steady-state which is characterized by higher

per-capita income and capital.• Graphical analysis: See next page.



Bachelor vs. master level macro education: Analysis of theeffect of an increase in the saving rate

• Bachelor level analysis: Graphical illustrationPage 12Makroökonomie I/Grundzüge der Makroökonomie ‹Nr.›

Wachstum und technischer Fortschritt: Der Einfluss der Sparquote

A ti d S t IAnstieg der Sparquote: I⇒ Je höher die Sparquote, desto höh i dhöher sind langfristig sowohl Produktion wie K it l iKapital im Verhältnis zu effektiver Arbeit.

12=⇒ Not answered: How long does the transition last?



Bachelor vs. master level macro education: Analysis of theeffect of an increase in the saving rate.

• Master level analysis:• Capital accumulation equation represents a dynamic equation:

kt+1 = sf (kt)− δkt . (8)

• Can be analyzed quantitatively.

0 10 20 30 40 50 60 70 80 90 100−0.5

−0.45

−0.4

−0.35

−0.3

−0.25

−0.2

−0.15

−0.1

−0.05

0Dyanmics of khat when k is initially below its steady−state

Time

khat

khat



Bachelor vs. master level macro education: Decompositionof macroeconomic time series.

• Bachelor level analysis:• No data analysis!!!

• Master level analysis:• Actual values of macroeconomics variables are sum of long-run and

short-run component (growth and business cycle perspective)• Decompose time series into two components using a filter:• Basic idea:

yt = y lrt + y sr

t . (9)



Bachelor vs. master macro: Decomposition ofmacroeconomic time series.

• Master level analysis:

1970 1975 1980 1985 1990 1995 2000 2005 2010−1

−0.5

0

0.5GNP: Original series

1970 1975 1980 1985 1990 1995 2000 2005 2010−1

−0.5

0

0.5Consumption: Original series

1970 1975 1980 1985 1990 1995 2000 2005 2010−1

−0.5

0

0.5Investment: Original series



Bachelor vs. master macro: Decomposition ofmacroeconomic time series.

• Master level analysis: Original and filtered time series

1970 1980 1990 2000 2010−1

−0.8

−0.6

−0.4

−0.2

0

0.2

0.4GNP: Original series and trend

1970 1980 1990 2000 2010−0.03

−0.02

−0.01

0

0.01

0.02

0.03GNP: Cyclical component

1970 1980 1990 2000 2010−1

−0.8

−0.6

−0.4

−0.2

0

0.2

0.4Consumption: Original series and trend

1970 1980 1990 2000 2010−0.02

−0.01

0

0.01

0.02Consumption: Cyclical component

1970 1980 1990 2000 2010−0.8

−0.6

−0.4

−0.2

0

0.2Investment: Original series and trend

1970 1980 1990 2000 2010−0.06

−0.04

−0.02

0

0.02

0.04

0.06Investment: Cyclical component


Organizational issues Contact information

Organizational issues

• Contact information• Instructor:

Michael GailHoelderlinstrasse 3, H-C 5326

• Office hours:After lecture and on appointment.

• Teaching assistants:Natalia Zabelina and Assem KhussainovaHoelderlinstrasse 3, H-B 5416/17

• Lectures:Tuesday, 2.00 p.m. - 4.00 p.m.; Room: H-A 3102First lecture: October 20th, 2015

• Classes:Monday, 4.00 p.m. - 6.00 p.m.; Room: H-A 3102First class: October 26th, 2015


Organizational issues Course information

Course information

• Course website:

http://www.wiwi.uni-siegen.de/gail/lehre/wintersemester_1516/

• Course requirements:• Final exam

• Readings:The main reference for the course is:

• Wickens, Michael (2011). Macroeconomic Theory – A DynamicGeneral Equilibrium Approach, 2nd ed., Princeton University Press,Princeton.


Organizational issues Course information

Course information

Course overview:1 Introduction (MW, Chapter 1)2 The centralized economy (MW, Chapter 2).3 Economic growth (MW, Chapter 3).4 The decentralized economy (MW, Chapter 4).5 Government: Expenditures and public finances (MW, Chapter 5).6 The Overlapping-Generations Model (MW, Chapter 6.3)7 Imperfectly flexible prices (MW, Chapter 9)8 Asset pricing and macroeconomics (MW, Chapter 11)9 Financial markets (MW, Chapter 12)10 Monetary policy (MW, Chapter 14)


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Dynamic Macroeconomics - Introduction · Bachelor versus master level macro education: Bachelorvs. masterlevelmacroeducation: Analysisofthe eﬀectofanaggregatedemandshock. Bachelorlevelanalysis