Econ 808 - Fall 2013

Syllabus

Problem Sets and Exams

Problem Set 1 (Due October 2)
Problem Set 2 (Due October 18)
Problem Set 3 (Due November 6)
Problem Set 4 (Due November 29)
Midterm (Fall 2003)
Midterm (Fall 2005)
Midterm (Fall 2006)
Midterm Solutions (Fall 2009)
Midterm and Solutions (Fall 2010)
Midterm and Solutions (Fall 2011)
Midterm and Solutions (Fall 2012)
Midterm and Solutions (Fall 2013)
Final (Fall 2003)
Final (Fall 2005)
Final (Fall 2006)
Final (Fall 2009)
Final (Fall 2010)
Final (Fall 2011)
Final (Fall 2012)

Programs

1.) The program bigshow.m takes AR and MA coefficients as input, and then plots a simulated time path, an impluse
response function, and the spectral density. It calls the programs ss.m, tf.m, impulse.m, dimpulse.m, shownew.m and
freq.m

2.) The program ex2.m solves the simple job search model in question #6 in problem set 1. It calls the program valit.m.
(These programs were written by Pierre Olivier-Weill, a Stanford graduate student at the time, now an UCLA professor)

3.) The file epdata.m contains Mehra and Prescott's (1985, JME) data. The program hanjagbnd.m uses this
data to compute and plot Hansen-Jagannathan bounds. These are used to answer question 5 in problem set 3.
Note, hanjanbnd.m calls the program PTIME.M to do some data manipulations, so you need to download this too.

Papers

Methodological Issues

This paper explains why macroeconomists worry so much about "microfoundations" (i.e., why it is so important to explain macroeconomic aggregates
in terms of the underlying preferences and technologies of individual agents).

Lucas (1976), "Econometric Policy Evaluation: A Critique", Carnegie-Rochester Conference Series on Public Policy

The next paper discusses the tension between positive and normative approaches to macroeconomics. It points to a potential logical inconsistency in the Lucas Critique.
It points out that the Lucas Critique may be unimportant from a purely positive perspective in which government policy is made endogenous.

Sargent (1984), "Autoregressions, Expectations, and Advice", American Economic Review

The next paper is Prescott's Nobel Lecture. It reviews the dramatic changes that have taken place during the past few decades in both the questions macroeconomists ask, and the way they
go about answering them.

Prescott (2006), "The Transformation of Macroeconomic Policy and Research", Journal of Political Economy

This next paper is Sargent's AEA presidential address. It reviews recent efforts to relax the Rational Expectations Hypothesis using models of learning and adaptive behavior. Saargent notes
that adaptive learning models typically produce Self-Confirming Equilibria, as opposed to Rational Expectations Equilibria. The key difference is that Self-Confirming Equilibria
only require beliefs to be correct (on average) along the equilibrium path. Beliefs about events that are not observed along the equilibrium path are allowed to be misspecified.

Sargent (2008), "Evolution and Intelligent Design", American Economic Review

Finally, the following popular press articles offer contrasting assessments of what the recent financial crisis means for macroeconomics. Krugman argues that it exposes the
fallacies of current macroeconomic methodology, and calls for a return to Keynesian economics. Lucas argues that this kind of diagnosis is incorrect, and the proposed cure is even worse.
Kocherlakota and Sargent point out that macroeconomists have in fact been spending a lot of time trying to incorporate frictions and market imperfections into their models.
However, this recent work has been rather technical, and has not filtered down to the textbooks yet.

Lucas (2009), "In Defense of the Dismal Science", The Economist
Krugman (2009), "How Did Economists Get It So Wrong?", New York Times Magazine
Kocherlakota (2009), "Some Thoughts on the State of Macro", unpublished mimeo.
Sargent (2010), "Minneapolis Fed Interview"
Bernanke (2010), "On the Implications of the Financial Crisis for Economics"
Lucas (2011), "Chicago Economics on Trial" (Wall Street Journal interview)
Nobel Prize Announcement (2011), "Empirical Macroeconomics" (summary of Sargent & Sims' work, from Nobel site)

Dynamic Optimization and Numerical Methods

Stokey's paper provides a relatively intuitive exposition of continuous-time dynamic optimization. Hall gives an informal overview of dynamic programming. The paper by Alvarex and
Stokey provides some existence and uniqueness results for a class of unbounded return functions, of the kind often encountered in economics.

Stokey (2003), "Introduction to Optimal Control", Unpublished notes
Hall (2010), "Basic Analysis of Forward-Looking Decision-Making", Chpt 1. from his recent monograph Forward-Looking Decision Making
Alvarez & Stokey (1998), "Dynamic Programming with Homogeneous Functions", Journal of Economic Theory

Uhlig's paper shows how to linearize nonlinear Euler equations, and applies a method of undetermined coefficients to solve them. DYNARE is an increasingly popular front end program used with Matlab (or Octave), which
solves, simulates, and estimates DSGE models. It is especially useful for analyzing models that are best described via their first-order conditions (eg, where equilibria are not Pareto Optimal). DYNARE is also useful
because it provides easy implementation of higher-order model approximations, which are important in capturing time-varying risk premia and precautionary saving behavior. They are also more accurate. You should check out
the DYNARE webpage (just type DYNARE in google!), and download a copy for yourself (it's FREE!) I've included a copy of the User Guide below, but it comes with the download. The paper by Sargent and his students
shows how DYNARE can be used to analyze a wide range of DSGE models. You should skim through it to see how models are coded into DYNARE. I've also included a few simple example programs: casskoop1.mod
simulates the effect of a temporary productivity shock in the Cass-Koopmans model. casskoop2.mod simulates the effect of a permanent productivity shock. casskoop3.mod simulates the effects of a sequence of random AR(1)
productivity shocks. casskoop4.mod uses the time paths generated by casskoop3.mod to estimate, using Bayesian methods, the coefficient of relative risk aversion in the standard Cass-Koopmans model. Finally, rbc1.mod
adds endogenous labor supply, and simulates a simple RBC model.

Uhlig (1999), "A Toolkit for Analyzing Nonlinear Dynamic Stochastic Models Easily", book chapter
Sargent and Stachurski (2013), "Quantiative Economics"
Juillard et al. (2011), "DYNARE: A User's Guide"
Sargent et al. (2010), "Practicing Dynare"
Examples: casskoop1.mod, casskoop2.mod, casskoop3.mod, casskoop4.mod, rbc1.mod

Unemployment

Shimer and Werning use a McCall search model to study unemployment insurance policies when agents are risk averse. They show that when agents can borrow and lend at a constant
riskless interest rate and have CARA preferences, a policy with constant UI benefits funded by a constant employment tax is optimal. The same policy is nearly optimal with CRRA preferences.
Ljungqvist and Sargent use a McCall search model to explain why European unemployment rates rose above those in the United States. They argue that it resulted from the interaction of the
relatively generous European unemployment compensation policies and an increase in microeconomic "turbulence".

Shimer & Werning (2008), "Liquidity and Insurance for the Unemployed", American Economic Review
Ljungqvist & Sargent (2003), "European Unemployment: From a Worker's Perspective", in Knowledge, Information, and Expectations in Macroeconomics

The next 4 papers survery the influential Mortensen-Pissarides search model of equilibrium unemployment. Mortensen provides an historical overview of the model, based on his Nobel lecture. Shimer points to several empirical
shortcomings of the model, and argues that the source of the problem lies in the Nash Bargaining wage setting assumption. Hornstein, Krusell and Violante discuss several recent efforts to address the empirical shortcomings of the
Mortensen_Pissarides model. They argue that none of the existing efforts are entirely satisfactory. Rogerson and Shimer also present mixed evidence on the empirical performance of search models. They consider both
cyclical fluctuations and long run trends in total hours worked for a number of OECD countries.

Mortensen (2011), "Markets With Search Frictions and the DMP Model", American Economic Review
Shimer (2005), "The Cyclical Behavior of Equilibrium Unemployment and Vacancies", American Economic Review
Hornstein, Krusell & Violante (2005), "Unemployment and Vacancy Fluctuations in the Mortensen-Pissarides Model", Richmond Fed Economic Review
Rogerson & Shimer (2010), "Search in Macroeconomic Models of the Labor Market", forthcoming in Handbook of Macroeconomics
Wright (2013), https://www.coursera.org/course/marketswithfrictions, online coursera course on search frictions. Check it out!

Moen extends the Mortensen-Pissarides model by introducing competitive wage setting, and argues that the resulting equilibrium is efficient.
Rogerson et al. provide a detailed overview of search-theoretic models of the labor market, with an emphasis on theory rather than empirical work. Ljungqvist & Sargent
review alternative approaches to understanding unemployment, and question Prescott's recent contention that tax rates explain differences between North American and European labor supply.

Moen (1997), "Competitive Search Equilibrium", Journal of Political Economy
Rogerson, Shimer & Wright (2005), "Search-Theoretic Models of the Labor Market", Journal of Economic Literature
Ljungqvist & Sargent (2005), "Jobs and Unemployment in Macroeconomic Theory: A Turbulence Laboratory", mimeo
Ljungqvist & Sargent (2008), "Two Questions About European Unemployment", Econometrica

Growth Theory

Lucas provides some perspective on the importance of understanding business cycles. He summarizes a research program that he initiated in 1987 which attempts to
calculate the welfare costs of business cycles. His original estimate suggested that business cycles have very small wefare effects - orders of magnitude smaller than the welfare
effects of growth. The following article argues that this original estimate is robust to a number of reasonable modifications.

Lucas (2003), "Macroeconomic Priorities", American Economic Review

The first 2 papers ignited the endogenous growth revolution. Lucas' model is based on human capital. The second
paper is a nice survey of endogenous growth theory. Chapter 4 from Acemoglu's text highlights the distinction between "proximate" and "fundamental"
determinants of growth. He discusses 4 different fundamental sources of growth, and argues that "institutions" are the most important.

Lucas (1988), "The Mechanics of Economic Development", Journal of Monetary Economics
Romer (1994), "The Origins of Endogenous Growth", Journal of Economic Perspectives
Acemoglu (2009), "Fundamental Determinants of Differences in Economic Performance", Chapter 4 from his text Introduction to Mondern Growth

The next paper points out that if the Solow model is true (with identical technologies across countries) there should be HUGE incentives for capital to flow into poor countries

Lucas (1990), "Why Doesn't Capital Flow from Rich to Poor Countries?", American Economic Review

The next two papers argue that it is impossible to explain the cross-sectional distribution of income levels unless you assume that technology levels differ.
Parente and Prescott offer political economy-based models to explain why technology does not diffuse across countries.

Prescott (1998), "Needed: A Theory of Total Factor Productivity", International Economic Review
Parente & Prescott (1999), "Monopoly Rights: A Barrier to Riches", American Economic Review

Asset Pricing

Lucas shows that with complete markets the intertemporal marginal rate of subsitution in consumption can be used to price assets. Kocherlakota reviews empirical work along
these lines. He argues that asset prices are difficult to explain from this perspective. Constantinides & Duffie show that incomplete markets with persistent idiosyncratic labor income
risk can explain the equity premium puzzle.

Lucas (1978), "Asset Prices in an Exchange Economy", Econometrica
Kocherlakota (1996), "The Equity Premium: It's Still a Puzzle", Journal of Economic Literature
Constantinides & Duffie (1996), "Asset Pricing with Heterogeneous Consumers", Journal of Political Economy
Backus, Routledge and Zin (2004), "Exotic Preferences for Macroeconomists", NBER Macroeconomics Annual, 2004
Barro (2006), "Rare Disasters and Asset Markets in the Twentieth Century", Quarterly Journal of Economics

Dynamic Optimal Taxation

Atkeson et al review Chamley and Judd's result that the (asymptotic) optimal tax rate on capital income is zero. They argue that this result is more general than commonly believed.
Aiyagari et al. reconciles Barro's (1979) tax-smoothing model with Lucas and Stokey's (1983) model. Based on Permanent-Income logic, Barro predicted that debt and taxes should
follow random walks. Lucas and Stokey's model predicts that tax rates should reflect the serial correlation structure of government expenditures. The key difference between these
models is that Barro assumes only state non-contingent debt, whereas Stokey and Lucas assume effectively complete markets. By ruling out state-contingent debt in Lucas and
Stokey's model, Aiyagari et al show that Ramsey taxes contain a near unit root, closely resembling the predictions of Barro's model. However, to obtain this result, exogenous
restrictions on government asset holdings must be imposed. Kocherlakota studies optimal taxation with private information. He develops a so-called "Mirrlees approach" to dynamic
optimal taxation, which relaxes the Ramsey taxation literature's (often implict) assumption that taxes are linear functions of income. He shows that wealth taxes are zero on average, but
are higher for poorer households. Poorer households pay higher wealth taxes purely for incentive reasons, i.e., to discourage hidden saving.

Atkeson, Chari & Kehoe (1999), "Taxing Capital Income: A Bad Idea", Minneapolis Fed Quarterly Review
Aiyagari, Marcet, Sargent & Seppala (2002), "Optimal Taxation without State-Contingent Debt", Journal of Polit. Economy
Kocherlakota (2006), "Advances in Dynamic Optimal Taxation", mimeo
Golosov, Tsyvinski, & Werning (2006), "New Dynamic Public Finance: A User's Guide", NBER Macroeconomics Annual, 2006

Lecture Slides

Lecture 1
Lecture 2
Lecture 3
Lecture 4
Lecture 5
Lecture 6
Lecture 7
Lecture 8
Lecture 9
Lecture 10
Lecture 11
Lecture 12
Lecture 13
Lecture 14
Lecture 15
Lecture 16
Lecture 17
Lecture 18
Lecture 19
Lecture 20
Lecture 21
Lecture 22