Advanced Macroeconomics An Easy Guide Introduction

Introduction Paul once stated that , even with all of our computers and with all of our information is not an exact science and is incapable of being an exact science . Perhaps this quote captures the view that the of , the study of aggregate behaviour of the economy , is full of loose ends and inconsistent statements that make it for economists to agree on anything . While there is truth to the fact that there are plenty of disagreements among , we believe such a negative view is unwarranted . Since the birth of as a discipline in the , in spite of all the uncertainties , inconsistencies , and crises , performance around the world has been strong . More recently , dramatic shocks , such as the Great Financial Crisis or the Covid pandemic , have been managed not without cost , but with effective damage control . There is much to celebrate in the of . was born under the pain of both US . and UK protracted recession of the 19305 . Until then , economics had dealt with markets , trade , and incentives , but it was never thought that there was place for a large and systematic breakdown of markets . High and persistent unemployment in the US . required a different approach . The main distinctive feature to be explained was the large disequilibrium in the labour market . How could it be that a massive number of people wanted to work , but could not a job ?

This led to the idea of the possibility of aggregate demand and thus of the potential role for government to prop it up , and , in doing so , restore economic normalcy Have people dig a hole and them up if necessary is the phrase by Keynes . In modern economic jargon , increase aggregate demand to move the equilibrium of the economy to a higher level of output . Thus , an active approach to and monetary policy developed , entrusting policy makers with the role of moderating the business cycle . The relationship was enshrined in the Phillips curve , a relationship that suggested a stable tradeoff between output and . If so , governments simply had to choose their preferred spot on that tradeoff . Then things changed . Higher in the and , challenged the view of a stable tradeoff between output and . In fact , increased with no gain in output , the age of had arrived . What had changed ?

The answer had to do with the role of expectations in The stable relationship between output and required static expectations . People did not expect , then the government found it was in its interest to generate a bit of but How to cite this book chapter , and , A . 2021 . Advanced An Easy Guide . Introduction , London Press . DOI License .

INTRODUCTION that meant people were always wrong ! As they started anticipating the , then its effect on employment faded away , and the effectiveness of macro policy had gone stale . The rational expectations revolution in , initiated in the , imposed the straint that a good macro model should allow agents in the model to understand it and act accordingly This was not only a theoretical purism , It was needed to explain what was actually happening in the real world . The methodological change took hold very quickly and was embraced by the profession . As a working assumption , it is a ubiquitous feature of up to today Then an additional challenge to the world of active policy came about . In the early , some started the real business cycles approach they studied the classical growth model that is , a model of optimal capital accumulation but added to it productivity shocks , The result was a simulated economy that , they argued , resembled on many dimensions the movements of the business cycle . This was a dramatic because it suggested that business cycles could actually be the result of optimal responses by rational economic agents , thereby eschewing the need for a stabilising policy response . What is more , active or monetary policy were not merely ineffective , as initially argued by the rational expectations view they could actually be harmful . This was the state of the discussion when a group of economists tackled the task of building a framework that recovered some of the features of the old activism , but in a model with fully rational agents . They modelled price formation and introduced market structures that departed from a perfectly competitive allocation . They adhered strictly to the assumptions of rational expectations and , which had the added advantage of allowing for explicit welfare analyses . Thus , the New approach was built . It also allowed for shocks , of course , and evolved into what is now known as dynamic stochastic general equilibrium ( models , evolved along those lines . Nowadays , models are used by any respectable central bank . Furthermore , because this type of model provides in the degree of price and market imperfections , it comprises a comprehensive framework nesting the different views about how individual markets operate , going all the way from the real business cycle approach to with ample . But the bottom line is that speaks with a common language . While differences in world views and policy preferences remain , having a common framework is a great achievement . It allows discussions to be framed around the parameters of a model ( and whether they match the empirical evidence ) and such discussions can be more productive than those that swirl around the philosophical underpinnings of ones policy . This book , to a large extent , follows this script , covering the different views and very importantly , the tools needed to speak the language of modern in what we believe is an accessible manner . That language is that of dynamic policy problems . We start with the Neoclassical Growth Model a framework to think about capital tion through the lens of optimal consumption choices which constitutes the basic grammar of that language of modern . It also allows us to spend the half of the book studying economic growth arguably the most important issue in , and one that , in recent decades , has taken up as much attention as the topic of business cycles , The study of growth will take us through the discussion of factor accumulation , productivity growth , the of both the capital stock and the growth rate , and empirical work in trying to understand the proximate and causes of growth , In that process , we also develop a second canonical model in modern the overlapping generations model . This lets us revisit some of the issues around capital accumulation and growth , as well as study key policy issues , such as the design of pension systems .

INTRODUCTION We then move to discuss issues of consumption and investment . These are the key , of course , and their study allows us to explore the power of the tools we developed in the part of the book , They also let us introduce the role of uncertainty and expectations , as well as the connections between and . Then , in the second half of the book , we turn to the study of business cycle , and what policy can and should do about it . We start with the real business cycle approach , as it is based on the neoclassical growth model , Then we turn to the approach , starting from the basic model , familiar to anyone with an undergraduate exposure to , but then showing how its modern version emerged , with the challenge of incorporating rational expectations , and then with the fundamentals of the New approach . Only then , we present the canonical New framework . Once we ve covered all this material , we discuss the scope and effectiveness of policy . We also go over what optimal policy would look like , as well as some of the reasons for why in practice it departs from those prescriptions , We then move to discuss monetary policy the relationship between money and prices , the debate on rules discretion , and the consensus that arose prior to the 2008 crisis and the Great Recession . We then cover the development of quantitative easing , as well as the constraints imposed by the zero lower bound on nominal interest rates . We off by discussing some current topics that have been the thinking of on the and monetary dimensions secular stagnation , the theory of the price level , and the role of bubbles and how policy should deal with them , As you can see from this whirlwind tour , the book covers a lot of material , Yet , it has a clear structure , We develop the basic tools in the part of the book , making clear exactly what we need at each step . All you need is a basic knowledge of calculus , differential equations , and some linear algebra and you can consult the mathematical appendix for the basics on the tools we and use in the book . Throughout , we make sure to introduce the tools not for their own sake , but in the context of studying issues and helping develop a framework for thinking about dynamic policy problems . We then study a range of policy issues , using those tools to bring you to the forefront of policy discussions . At the very end , you will also two appendices for those interested in tackling the challenge of running and simulating their own models , All in all , was right that can not be an exact science . Still , there is a heck of a lot to learn , enjoy and discover and this , we hope , will help you become an informed participant in exciting policy debates . Enjoy ! Note Surprisingly , the answer came from the most unexpected quarter the study of agricultural markets . As early as 1960 Muth was studying the cobweb model , a standard model in agricultural . In this model the farmers look at the harvest price to decide how much they plant , but then this provides a supply the following year which is inconsistent with this price . For example a bad harvest implies a high price , a high price implies lots of planting , a big harvest next year and thus a low price ! The low price motivates less planting , but then the small harvest leads to a high price the following year ! In this model , farmers were systematically wrong , and kept being wrong all the time . This is nonsense , argued Muth . Not only should they learn , they know the market and they should plant the equilibrium price , namely the price that induces the amount of planting that implies that next year that will be the price . There are no cycles , no mistakes , the market equilibrium holds from day one ! Transferred to policy , something similar was happening .