Lecture notes for Macroeconomics I , 2004

Please do NOT distribute without permission! Comments and suggestions are welcome. 1 2 Chapter 1 Introduction These lecture notes cover a one-semester course. The overriding goal of the course is to begin provide methodological tools for advanced research in macroeconomics. The emphasis is on theory, although data guides the theoretical explorations. We build entirely on models with microfoundations, i.e., models where behavior is derived from basic assumptions on consumers' preferences, production technologies, information, and so on. Behavior is always assumed to be rational: given the restrictions imposed by the primi-tives, all actors in the economic models are assumed to maximize their objectives. Macroeconomic studies emphasize decisions with a time dimension, such as various forms of investments. Moreover, it is often useful to assume that the time horizon is infinite. This makes dynamic optimization a necessary part of the tools we need to cover, and the first significant fraction of the course goes through, in turn, sequential maximization and dynamic programming. We assume throughout that time is discrete, since it leads to simpler and more intuitive mathematics. The baseline macroeconomic model we use is based on the assumption of perfect competition. Current research often departs from this assumption in various ways, but it is important to understand the baseline in order to fully understand the extensions. Therefore , we also spend significant time on the concepts of dynamic competitive equilibrium, both expressed in the sequence form and recursively (using dynamic programming). In this context, the welfare properties of our dynamic equilibria are studied. Infinite-horizon models can employ different assumptions about the time horizon of each economic actor. We study two extreme cases: (i) all consumers (really, dynasties) live forever-the infinitely-lived agent model-and (ii) consumers have finite and deterministic lifetimes but there are consumers of different generations living at any point in time-the overlapping-generations model. These two cases share many features but also have important differences. Most of the course material is built on infinitely-lived agents, but we also study the overlapping-generations model in some depth. Finally, many macroeconomic issues involve uncertainty. Therefore, we spend some time on how to introduce it into our models, both mathematically and in terms of economic concepts. The second part of the course notes goes over some important macroeconomic topics. These involve growth and business cycle analysis, asset pricing, fiscal policy, monetary economics, unemployment, and inequality. Here, few new tools are introduced; we instead simply apply …