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University of Kiel
Dynamic Macroeconomic Theory
Email: sacht@economics.uni-kiel.de
Organization
Room: 308
Visiting Hours: by appointment
Password:
https://lms.uni-iel.de/auth/RepositoryEntry/667582464/CourseNode/92377868517642
Trigger warning:
Romer, P., The Trouble With Macroeconomics, New York University, September
2016
However: Adding small amounts of noise does mostly not change the qualitative
Course Outline
outcome of the dynamics so that for theoretical purposes the analysis of the
deterministic analogue is appropriate.
To get an idea what we are going to talk about, check out the (although
mathematical) representation of love & hate dynamics by J.C. Sprott
(Dynamical Models of Love, Nonlinear Dynamics, Psychology, and Life Sciences,
Vol. 8, No. 3, July, 2004).
1. Linear Difference equations
1.1. First and Second Order Difference Equations
1.1.1. Mathematical Background
1.1.2. Economic Application: Multiplier-Accelerator Interaction
1.2. Higher-order Difference Equations and Simultaneous Systems of
Difference Equations
1.2.1. Mathematical Background 4
1.2.2. Economic Application: Inventory Cycles
Dynamic Macroeconomic Theory
4. Nonlinear Dynamics
4.1. Limit Cycles and Bifurcations
Course Outline
dyt
(2) differential equation: = h ( yt , t )
dt
(n )
but there might be also higher derivatives: a0 y + a1 y (n 1) + ... + an 1 y + an y = g (t )
g ( yt , yt 1 ,..., yt n ) =
nonlinear equations:
8
1.1 First and Second Order Difference
Equation
c1 yt + c0 yt 1 = g (t )
with time-dependent function g (t ) this is called a non homogenous equation.
Homogeneous equation : c1 yt + c0 yt 1 = 0
c
or: yt yt 1 = 0 , = 0
c1
y0 = A
Solution via iteration: y1 = y0 = A
y 2 = (y0 ) etc. yt = t y0
= t A
9
1.1 First and Second Order Difference
Equation
y*
( y*,t*) y* = t* A A =
t*
Types of dynamic behavior:
11
1.1 First and Second Order Difference
Equation
[ ] [ ]
c1 y + c0 y = g (t ) c1 y + t A + c0 y + t 1 A = g (t )
is also a solution!
12
1.1 First and Second Order Difference
Equation
Try a function with the same form of g(t) but with undetermined constants
Substitute into non-homogeneous equation and determine the coefficients
Examples:
13
1.1 First and Second Order Difference
Equation
( 2) g (t ) = B d t try : y = Cd t
c1Cd t + c0Cd t 1 = Bd t
d t 1 (c1Cd + c0C Bd ) = 0
Bd Bd
C= , y= dt
c1d + c0 c1d + c0
14
1.1 First and Second Order Difference
Equation
c0 t
A = y 0 y yt = ( ) ( y0 y ) + y
c1
15
1.1 First and Second Order Difference
Equation
General form: c2 yt + c1 yt 1 + c 0 yt 2 = g (t )
Homogeneous equation: c2 yt + c1 yt 1 + c 0 yt 2 = 0
or: c c
yt + a1 yt 1 + a 2 yt 2 = 0 , a1 = 1 , a2 = 0
c2 c2
yt t t + a1 t -1 + a 2 t -2 = 0
t - 2 ( 2 + a1 + a 2 ) = 0 characteristic equation
2
a1 (a 1 4a 2 )1/ 2
1, 2 = two solutions
2 16
Second-Order Linear Difference Equations
Cases:
Since one only has one solution, one tests as a second solution
2 = t t yt = A1t + A2t t
17
Second-Order Linear Difference Equations
1 1
Try a solution: 1,2 = i = a1 -1 ( 4a2 a12 )1/ 2
2 2
yt would be real-valued if A, A were complex conjugate!
18
Second-Order Linear Difference Equations
r cos = , r sin = r2 = 2 + 2
Im() r = ( 2 + 2 )1/ 2
(modulus or absolute value)
r
Re()
19
Second-Order Linear Difference Equations
explosive >
constant oscillations if a2 = 1
dampened <
21
Second-Order Linear Difference Equations
-1 1
Additionally, cases with both 1,2 < -1 or > 1 can be excluded by the condition: 1 2 < 1
22
Second-Order Linear Difference Equations
(3) f ( 1) = 1 a1 + a2 > 0
23
Second-Order Linear Difference Equations
24
Second-Order Linear Difference Equations
Example: c2 yt + c1 yt 1 + c0 yt 2 = g
y : c2 y + c1 y + c0 y = g
yt = A11t + A2 t2 + c +cg + c
0 1
1 2 32
y
Example: (t = 0, y0 ) (t = 1, y1 ) lead to
y0 = A1 + A2 + y , y1 = A11 + A2 2 + y A1 , A2
25
1.1.2 Economic Application: Multiplier
Accelerator Interaction
26
1.1.2 Economic Application: Multiplier-
Accelerator Interaction
Model structure:
( 2) I t = I t + I t investment
27
1.1.2 Economic Application: Multiplier
Accelerator Interaction
Yt = bYt-1 + k (Ct Ct 1 ) + G =
= bYt-1 + kb(Yt-1 Yt- 2 ) + G
G
Particular solution: try Yt = Y Y b(1 + k )Y + bkY = G Y =
1 b
28
1.1.2 Economic Application: Multiplier-
Accelerator Interaction
Stability conditions:
1 b(1 + k ) + bk > 0 1 b > 0 o.k.
1 bk > 0 (?) product of the roots
1 + b(1 + k ) + bk > 0 o.k.
b k < 1 b < 1/ k
Oscillations:
= b 2 (1 + k ) 2 4bk
> > 4k
= 0 if b= 2
< < (1 + k ) 29
1.1 First and Second Order Difference
Equation
30
1.1.2 Economic Application: Multiplier
Accelerator Interaction
A( 1 + g )t b( 1 + k ) A( 1 + g )t 1 + bkA( 1 + g )t 2 = G0 ( 1 + g )t
{[ ] }
( 1 + g )t 2 A ( 1 + g )2 b( 1 + k )( 1 + g ) + bk G0 ( 1 + g )2 = 0
G0 ( 1 + g )2
y= ( 1 + g )t > 0
( 1 + g )2 b( 1 + k )( 1 + g ) + bk
31
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
(for PhD students)
i =0
Hence, one finds that y t = (b) L xt = (b)i xt i
i i
is the valid particular
i =0 i =0
solution since it satisfies the difference equation.
Note: these sequences converge only if |b| < 1 or || < 1, i.e. if the system is stable.
33
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
Particular solution here = geometrically declining sum of all past or future values of xt
depending on whether the equation is stable or unstable.
Alternative expansion: ( 1 L) = ( 1 ) i Li
1
i =1
( 1 L) 1 = 1 L1 (1 L1 ) 1
Application: forward looking models are typically mathematically unstable, but can be
represented via second type of solution concept for particular solution.
34
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
Dt = a + bpt , St = a1 + b1 pt 1
Dt = St bpt b1 pt 1 = a1 a
b1 a1 a
pt pt 1 =
b b
b a a
pt = A( 1 ) t + 1
b b b1
Equilibrium price is particular solution,
Dt = a + bpt , St = a1 + b1 pt
e
D = S a + bpt = a1 + b1{pt 1 + c( p N pt 1 )}
a1 a
Assume:
p N = p* =
b b1
t
b1 (1 c)
Then: pt = A + p*
b
Stable if b1 (1 c) < b
more stable than naive expectations if c<1 36
faster convergence or switch from instability to stability
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
e
Solution of homogeneous equation for pte: pt = A(1 )t
Particular solution: e
pt = (1 ) L pt 1 = (1 )i pt 1i
i i
i =0 i =0
37
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
General solution:
e
pt = A(1 ) + (1 ) i pt 1i
t
i =0
e St a1
Solution for pt: pt =
b1
St a1 S a
= (1 ) t 1 1 + Pt 1
b1 b1
St = (1 ) St 1 + a1 + b1 Pt 1
38
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
Since Dt = St , t :
( a1 a )
pt [( b1
b
)
1 + 1 pt 1 =] b
Stability condition:
( b1
b
)
1 +1 < 1 1 2
{
< b1
b
<1
< 1 for 0< <1
39
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
Variables now are deviations from equilibrium, demand consists of consumption and
inventory component
consumption: Ct = pt
e
production: Pt = pt + xt
inventory: I t = ( pte+1 pt )
equilibrium: Ct + I t I t 1 = Pt
with xt as exogenous factors.
40
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
pt +1 (2 + + ) pt + pt 1 = xt
2 + + 1
pt pt 1 + pt 2 = xt 1
Homogeneous part leads to characteristic equation:
2 + +
2 +1 = 0
(2 + + ) 2 4 2
Discriminant: = 2
>0
1
Since a2=1 stability conditions are violated; note: 1 2 = 1 1 =
one stable, one unstable 2 41
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
yt + a1 yt 1 + a2 yt 2 = X t
(1 + a1 L + a2 L2 ) yt = X t
1
yt = 2
Xt
1 + a1 L + a2 L
Denote by F = L-1 the forward operator:
2 2
1 + a1 L + a2 L2 = L2 ( F 2 + a1 F + a2 )
14 4244 3
=( F F1 )( F F2 )
1 + a1 L + a2 L2 = L2 ( F 1 )( F 2 )
Hence:
= ( LF 1 L)( LF 2 L)
= (1 1 L)(1 2 L)
and 1
(1 1L )(1 2 L )
= 111L + 122 L , 1 = 1
1 2
, 2 = 2
1 2
yt = 111L X t + 122 L X t
Hence:
= 1 X t i + 2 i2 X t i
i
1
(backward solution)
i =0 i =0
43
1.1.3 A First Look at Anticipation:
Backward and Forward Solutions
i i
Or:
yt = 1 1 X t +i 2
i =1 1 i =1
( )X1
2 t +i
In the RE cobweb case: backward solution for stable root, forward solution for unstable
root.
i
pt = 1 1i X t i 2 1 X t +i
i =0 i =1 2
= 1 1i X t i 2 1i X t +i , 1 < 1
i =0 i =1
Particular solution is geometrically weighted average of all past, present and (known)
44