Harvard University

Harvard Kennedy School

Spring 2011

API 119: Advanced Macroeconomics for the Open Economy II

Prof. Filipe Campante
(filipe_campante@harvard.edu)

Class Meetings: Tu-Th 1:10-2:30pm (L140)

Office Hours: Thu 3:00-5:00pm (Littauer 203)
Assistant: Beth Tremblay (beth_tremblay@harvard.edu)
Teaching Fellow: Cristobal Marshall (cmarshall@mit.edu)
Course Assistants: Musa Kpaka (musa_kpaka@hks11.harvard.edu)
Annoula Rysova (annoula_rysova@hks11.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-Martin‟s 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. Acemoglu‟s 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. Romer‟s (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. Acemoglu‟s (DA) Introduction to Modern
Economic Growth (2009) (in the first part of the course), by O. Blanchard and S. Fischer‟s (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 8 (in class), and the final will be on May 9 (Mon, 2-
5pm). The problem sets will be handed out every other Tuesday, and will be due the
Wednesday of the following week, by 10am, in the Littauer 2nd floor drop boxes.

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.‟ Suárez
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 doesn‟t 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 15th 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 17th and Feb 22nd 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.

Acemoğlu, D. S. Johnson and J. Robinson (2001) “The Colonial Origins of Comparative

Development: An Empirical Investigation” The American Economic Review, Vol. 91, No. 5

Acemoğlu, 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

Feb 24th and March 1st 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 3rd 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 8th (in class)
III. Consumption and Investment

March 10th and March 22nd Consumption

* DR. Chapter 7.

March 24th 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 29th 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.

March 31st 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)
April 5th The Great Recession: Whither Macroeconomics?

Caballero, R. (2010) “Macroeconomics after the Crisis: Time to Deal with the Pretense-of-
Knowledge Syndrome” Journal of Economic Perspectives, Vol. 24, No. 4.

Fuster, A., D. Laibson and B. Mendel (2010) “Natural Expectations and Macroeconomic
Fluctuations” Journal of Economic Perspectives, Vol. 24, No. 4.

Ohanian, L. (2010) “The Economic Crisis from a Neoclassical Perspective” Journal of

Economic Perspectives, Vol. 24, No. 4.

Woodford, M. (2010) “Financial Intermediation and Macroeconomic Analysis” Journal of

Economic Perspectives, Vol. 24, No. 4.

April 7th 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 12th and 14th Public debt dynamics and the effectiveness of fiscal policy

* DR. Chapter 11.1-11.3

* Barro, R. (1974) “Are Government Bonds Net Wealth?” Journal of Political Economy, Vo. 82,
No. 6.

* Alesina, A. (2010) “Fiscal Adjustments: Lessons from Recent History”

(http://www.economics.harvard.edu/faculty/alesina/files/Fiscal%2BAdjustments_lessons.
pdf)

Christiano, L., M. Eichenbaum and S. Rebelo (2009) “When is the Government Spending
Multiplier Large?” (http://faculty.wcas.northwestern.edu/~yona/research/Multiplier-
version12.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.

* Blanchard, Olivier, Giovanni Dell‟Ariccia, Paolo Mauro (2010) “Rethinking

Macroeconomic Policy,” IMF Staff Position Note
(http://www.imf.org/external/pubs/ft/spn/2010/spn1003.pdf)

Svensson, Lars. (1997) "Inflation Forecast Targeting: Implementing and Monitoring

Inflation Targets," European Economic Review, Vol. 41: 1111-1146.

Final Exam date: May 9th (Monday), 2-5pm