Harvard University Harvard Kennedy School Spring 2010 API 119: Advanced Macroeconomics for the Open Economy

II Prof. Filipe Campante (filipe_campante@harvard.edu) Office Hours: Wed 3:00-5:00pm (Littauer 203) Assistant: Beth Tremblay (beth_tremblay@harvard.edu) Teaching Fellow: Cristobal Marshall (cristobal_marshall@hks10.harvard.edu) Course Assistants: Daniella Llanos (daniela_llanos@hks10.harvard.edu) Andrew Matheny (andrew_matheny@hks10.harvard.edu) Overview This is an advanced course on macroeconomics for students who have a good background in micro and macro theory, econometrics, and mathematical techniques for economic analysis. The objective of the course is to develop expertise with economic models used for the analysis of macroeconomic policy issues. The course relies on recent economic research with a policy focus, in order to build a substantive understanding of current issues in macroeconomics, as well as a familiarity with the core tools of macroeconomics. Our motto is to be rigorous, so that we know that our thinking is solid and well-grounded, and relevant, for we want to have impact on policy changes in the real world. Prerequisites Macroeconomic theory at the intermediate level; multivariate calculus and dynamic optimization (rudiments of control theory) are necessary. The course freely uses the techniques of dynamic optimization, mostly in continuous time. As background reading I recommend the math Appendix of R. Barro and X. Sala-i-Martins Economic Growth (2nd ed., McGraw-Hill, 2004). You may also want to look at the somewhat more detailed treatment in the notes Dynamic Optimization in Continuous Time Economic Models (A Guide for the Perplexed) by M. Obstfeld, at http://emlab.Berkeley.EDU/users/obstfeld/e202b/e202b.html. For a more advanced, but very compact and complete treatment, see Chapter 7 in D. Acemolus Introduction to Modern Economic Growth (Princeton University Press, 2009). This course is open to non-MPA/ID students by permission of the instructor only. Readings No single text covers all the material for the course. D. Romers (DR) Advanced Macroeconomics (3rd ed., McGraw-Hill, 2006) is a book that has a nice coverage of recent research in macroeconomics, and will thus be our main source for background reading. In fact, given the large amount of material we expect you to read from this source we have not included Romer chapters in the package. In class I will be drawing mostly from this book, with some additional elements being provided by D. Acemolus (DA) Introduction to Modern

Economic Growth (2009) (in the first part of the course), by O. Blanchard and S. Fischers (BF) Lectures on Macroeconomics (MIT Press, 1989), and by a number of mostly classical articles in the field. Because this is a course to set up the stage for your understanding of macroeconomics, with a few exceptions I have chosen to direct you to seminal or survey articles in each topic, relying on DR for a discussion of the developments thereafter. The reading list is short, under the assumption that you will skim through most of the pieces. Still there are two types of readings, some which you are required to read (indicated by a *), while others are included as background material for what I do in class and which may be useful reference points to clarify lecture material. For those interested in development at large, there are a couple of fairly recent books that provide interesting reading, and a good link with material that is covered in class. Among these: Easterly, William (2001) The Elusive Quest for Growth: Economists Adventures and Misadventures in the Tropics, Cambridge University Press. Helpman, Elhanan (2004), The Mystery of Economic Growth, Harvard University Press. Lucas, Robert (2002) Lectures on Economic Growth, Cambridge: Harvard University Press. Rodrik, Dani (2007), One Economics, Many Recipes: Globalization, Institutions and Economic Growth, Princeton University Press. Grading Grading will be based on: a midterm (30%) problem sets (20%) a final (50%)

The midterm will take place on March 10 (in class), and the final will be on May 10 (Mon, 25pm). The problem sets will be handed out every other Monday, and will be due the Wednesday of the following week. Why do we do theory? This is a recurrent question in a course like this one, which attempts to address very practical questions with relatively abstract models. An excellent (and very readable) justification of why we use these abstract models was written by Paul Krugman (http://web.mit.edu/krugman/www/dishpan.html): models, like maps, constitute a useful and indispensable source of simplification without which we cannot comprehend the world. Fiction is perhaps the best way to make this point, as illustrated by Argentinean writer Jorge Luis Borges in his one-paragraph short story entitled On rigor in science:

... In that empire, the art of cartography reached such perfection that the map of one province alone covered up the whole of a city, and the map of the empire, the whole of a province. In time, those unconscionable maps did not satisfy, and the colleges of cartographers set up a map of the empire which had the size of the empire itself and coincided with it point by point. Less addicted to the study of cartography, succeeding generations understood that this widespread map was useless and not without impiety they abandoned it to the inclemency of the sun and of the winters. In the deserts of the west some mangled ruins of the map lasted on, inhabited by animals and beggars; in the whole country there are no other relics of the disciplines of geography. Surez Miranda, Viajes de varones prudentes, Book IV, Chapter XLV, Urida, 1658. A Universal History of Infamy, Penguin, London, 1975 Indeed, as Dani Rodrik remarks, in his highly recommended web log (http://rodrik.typepad.com/dani_rodriks_weblog/2007/09/why-we-use-math.html), abstract mathematical models possess the quality of aiding clear analysis with explicit linkages between premises and conclusions. Metaphors and intuition more often than not lack the precision needed in intellectual debate for policy formulation. Course Contents The course will cover five main areas of the macroeconomics debate: i) growth, ii) overlapping generations models and social security, iii) consumption and investment, iv) business cycles, and v) a discussion of fiscal and monetary policy. I. Growth Jan 25th and Jan 27th Introduction and the Solow model * DR, Chapter 1. * Barro, R. and X. Sala-i-Martin (2004), Economic Growth (2nd ed), McGraw-Hill, Introduction. * Easterly, W. (2001) The Elusive Quest for Growth: Economists Adventures and Misadventures in the Tropics, Cambridge University Press, Chapter 2 and 3. DA, Chapter 1. Solow, R. (1956) A Contribution to the Theory of Economic Growth. Quarterly Journal of Economics 70:65-94. Feb. 1st and 3rd The Ramsey model and optimal savings * DR. Chapter 2. Part A * BF, Chapter 2. Subsections 1-3

Feb 8th Endogenous growth models I: Escaping diminishing returns * DR Chapter 3. Part A. * Lucas, R. (1990) Why doesnt Capital Flow from Rich to Poor Countries American Economic Review, Vol. 80, No. 2, May. * Romer P. (1989), Capital Accumulation in the Theory of Long-Run Growth, in Robert Barro, ed. Modern Business Cycle Theory, Harvard University Press. DA Chapter 11. Feb 10th Endogenous growth models II: Technological change * DR Chapter 3. Part A. * Aghion, P. and P. Howitt (2006) Appropriate Growth Policy: A Unifying Framework, Journal of the European Economic Association, April-May. * Lucas, R. (1993) Making a Miracle, Econometrica, Vol. 61 (2), pp. 251-272. * Kremer, M. (1993) Population Growth and Technological Change One Million BC to 1990, Quarterly Journal of Economics, August. Parente, S. and E. Prescott (1999) Monopoly Rights: A Barrier to Riches, American Economic Review, Vol. 89 (5), pp. 1216-1233. Feb 17th Poverty traps and the big push * Diamond, P. (1982) Aggregate Demand Management in a Search Equilibrium Journal of Political Economy, Vol. 90, No. 5. * Easterly, W. (2005) Reliving the 50s: the Big Push, Poverty Traps, and Takeoffs in Economic Development, Center for Global Development, Working paper No. 65. * Murphy, K., A. Shleifer, and R. Vishny (1989), Industrialization and the Big Push, Journal of Political Economy, October. DA, Chapter 21.5.

Feb 22nd and Feb 24th What do the data say? Proximate and fundamental causes of differences in economic performance * DA Chapters 3 and 4. * Mankiw, G., D. Romer and D. Weil (1992) A Contribution to the Empirics of Economic Growth The Quarterly Journal of Economics, Vol. 107, No 2. * Hall, R. and C. Jones (1999) Why do Some Countries Produce so Much More Output per Worker than Others? The Quarterly Journal of Economics, February. Rodrik, D. (2005) Why We Learn Nothing from Regressing Economic Growth on Policies, Mimeo, Kennedy School, March. Acemolu, D. S. Johnson and J. Robinson (2001) The Colonial Origins of Comparative Development: An Empirical Investigation The American Economic Review, Vol. 91, No. 5 Acemolu, D. S. Johnson and J. Robinson (2001) Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution The Quarterly Journal of Economics, Vol. 117. Jones, C. and P. Romer (2009) The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital (http://www.stanford.edu/~chadj/Kaldor200.pdf) II. Overlapping Generations Models March 1st and March 3rd The basic setup * DR, Chapter 2. Part B. Diamond, P. (1965) National Debt in a Neoclassical Growth Model, American Economic Review, Vol. 55, 5, December, pp. 1126-1150. March 8th Social security and transitions * BF, Chapter 3, subsection 1-2. * Feldstein, M. (1996) "The Missing Piece in Policy Analysis: Social Security Reform," The Richard T. Ely Lecture, in American Economic Review, Vol. 86, No. 2, May, pp 1-14. * Feldstein, M (1997) Transition to a Fully Funded Pension System: Five Economic Issues NBER Working Paper, No. 6149. End of Topics covered in Midterm Midterm date: March 10 (in class)

III. Consumption and Investment March 22nd and March 24th Consumption * DR. Chapter 7. March 29th Investment * DR Chapter 8 * BF, Chapter 2.4 Sachs, J. (1981) The Current Account and Macroeconomic Adjustment in the 1970s, Brookings Papers on Economic Activity. Summers L. (1981) Taxation and Corporate Investment: A Q-Theory Approach Brookings Papers on Economic Activity.

IV. Business Cycles March 31st Real Business Cycles * DR Chapter 4. * Prescott, E. (1986) Theory Ahead of Business Cycle Measurement, Federal Reserve Bank of Minneapolis FED Quarterly. McCandless, G. (2008) The ABCs of RBCs. Harvard University Press, Chapter 6. April 5th and 7th Keynesian theories of fluctuations: a primer * DR Chapters 5 and 6 Friedman, M. (1968) On the role of Monetary Policy, American Economic Review, Vol. 58, No. 1. Lucas, R. (1973) Some International Evidence on Output-Inflation Tradeoffs The American Economic Review, Vol. 63, No. 3 Mankiw, G. and D. Romer (1991) Introduction in Mankiw G. and D. Romer (eds) New Keynesian Economics, Cambridge MIT Press. (This is just a long list of contributions that you can use as reference)

Akerlof, G. (2002) Behavioral Macroeconomics and Macroeconomic Behavior The American Economic Review, Vol. 92, No. 3. April 12th Unemployment * DR Chapter 9 Summers, L. (1988) Relative Wages, Efficiency Wages, and Keynesian Unemployment The American Economic Review, Vol. 78, No. 2. Pissarides, C. (1988) The Search Equilibrium Approach to Fluctuations in Employment The American Economic Review, Vol. 78, No. 2. V. Fiscal and Monetary Policy April 14th Public debt dynamics * DR. Chapter 11.1-11.3 * Barro, R. (1974) Are Government Bonds Net Wealth? Journal of Political Economy, Vo. 82, No. 6. Christiano, L., M. Eichenbaum and S. Rebelo (2009) When is the Government Spending Multiplier Large? (http://faculty.wcas.northwestern.edu/~yona/research/Multiplierversion12.pdf) April 19th The long-run determinants of fiscal policy * DR Chapter 11.4-11.9 * Barro, R. (1979) On the determination of Public Debt, Journal of Political Economy, Vol. 87. * Alesina, A. and R. Perotti (1994) The Political Economy of Budget Deficits IMF Staff Papers,Vol. 42. April 21st and 26th Monetary Policy: inflation and deficits * DR, Ch. 10.1-10.2-10.8-10.9 * BF Chapter 4. Sections 4.1, 4.2, 4.5 and 4.6 Cagan P. (1956) Monetary Dynamics of Hyperinflation in M. Friedman (ed.) Studies in the Quantity Theory of Money.

Dornbusch, R., F. Sturzenegger, H. Wolf (1990) Extreme Inflation: Dynamics and Stabilization, Brookings Papers on Economic Activity, Vol. 2 BF Chapter 8, Section 8.2 and Chapter 10, Section 10.5.

April 28th A discussion on monetary policy DR Chapter 10.6-10.7. * Mishkin, Frederic (2006) Monetary Policy Strategy: How did we get here? NBER Working Paper No. 12515, September. * The Monetary-Policy Maze, The Economist, Apr 23, 2009. Svensson, Lars. (1997) "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," European Economic Review, Vol. 41: 1111-1146.

Final Exam date: May 10 (Monday), 2-5pm