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Macroeconomics 3 (ECO-CO-MACRO-3)

ECO-CO-MACRO-3

Description

Module description:

This course provides a rigorous treatment of the foundational dynamic macroeconomic models that constitute a core component of the training of research economists. Its objective is to equip students with a solid understanding of modern dynamic general equilibrium macroeconomic models and to train them to confront these models with the data using both partial- and full-information methods. Emphasis is placed on models with nominal rigidities and on the policy challenges faced by central banks within these frameworks. The course begins with asset pricing in complete-markets endowment economies, introducing the notion of stochastic discount factor and examining key financial puzzles in consumption-based models, together with the mechanisms proposed to resolve them. It then moves to efficient production economies, which provide the foundation for the baseline New Keynesian model. Finally, it studies economies with real and nominal frictions, leading to the New Keynesian framework and its implications for monetary policy. The course also introduces the structural estimation of DSGE models, focusing on Bayesian methods and their implementation, to equip students with advanced tools for confronting dynamic macroeconomic models with time series data.

Learning outcomes:
By the end of this module, students should be able to:

• Understand and solve dynamic macroeconomic models.

• Derive and evaluate asset pricing implications using the stochastic discount factor.

• Understand the structure and key predictions of the New Keynesian framework, including core concepts such as the output gap and the natural rate of interest.

• Analyze the role of real and nominal frictions in the propagation of key macroeconomic shocks.

• Characterize optimal monetary policy under efficient and inefficient shocks, and under commitment and discretion.

• Implement and interpret structural estimation methods for DSGE models, including Bayesian techniques.

Assessment:

The grade will be based on a final exam (90%) and two problem sets (10%)

Module structure:
Week 1:Asset Pricing Theory

Topics:

• Complete markets

• Arrow-Debreu economy and aggregation

• The Lucas asset pricing model

• Stochastic discount factor

• Equity premium puzzle

• Hansen-Jagannathan bounds

•Recursive preferences

Main Readings:

• Lucas, Robert E., Jr. (1978). "Asset Prices in an Exchange Economy," Econometrica, 46(6), 1429–1445.

• Stokey, Nancy L., Robert E. Lucas Jr., and Edward C. Prescott. (1989). Recursive Methods in Economic Dynamics. Harvard University Press.

• Ljungqvist, Lars, and Thomas J. Sargent. Recursive Macroeconomic Theory. 4th ed. Cambridge, MA: MIT Press, 2018. 

Week 2: The Baseline New Keynesian model - Part I

Topics:

• Efficient production economy: The Neo-Classical Model

• Log-linearization and Rational Expectations equilibrium

• Indeterminacy of nominal variables

• Key empirical shortcomings of the Neo-classical Model

Main Readings:

• Gali, Jordi. (2015). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. 2nd edition, Princeton University Press.

• Woodford, Michael. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press 

Week 3: The Baseline New Keynesian model - Part II

Topics:

• Monopolistic competition and nominal rigidities

• Inefficient steady-state equilibrium

• The New Keynesian Phillips curve

• The output gap and the natural rate of interest

• Monetary policy and nominal anchoring

Main Readings:

• Gali, Jordi. (2015). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. 2nd edition, Princeton University Press.

• Woodford, Michael. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press 

Week 4: Structural Estimation

Topics:

• Partial information methods: Methods of moments, GMM, IRF matching, simulated method of moments

• Full information methods: Bayesian estimation and evaluation

• Kalman filter

• Prior selection

• Posterior simulators

• Dynare applications

Main Readings:

• An, Sungbae and Schorfheide, Frank. (2007). Bayesian Analysis of DSGE Models. Econometric Reviews, 26(2–4), 113–172.

• Herbst, Edward and Schorfheide, Frank. (2015). Bayesian Estimation of DSGE Models. In Handbook of Macroeconomics, Vol. 2, Elsevier. 

Week 5: Optimal Monetary Policy

Topics:

• Divine coincidence

• Monetary policy trade-offs: discretion vs. commitment

Main Readings:

• Clarida, Richard, Gali, Jordi and Gertler, Mark. (1999). The Science of Monetary Policy: A New Keynesian Perspective. Journal of Economic Literature, 37(4), 1661–1707.

• Gali, Jordi. (2015). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. 2nd edition, Princeton University Press.

• Woodford, Michael. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press

Bibliography and further readings

Main references:

• Gali, Jordi. (2015). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. 2nd edition, Princeton University Press.

• Herbst, Edward and Schorfheide, Frank. (2015). Bayesian Estimation of DSGE Models. In Handbook of Macroeconomics, Vol. 2, Elsevier.

• Ljungqvist, Lars, and Thomas J. Sargent. Recursive Macroeconomic Theory. 4th ed. Cambridge, MA: MIT Press, 2018.

• Stokey, Nancy L., Robert E. Lucas Jr., and Edward C. Prescott. (1989). Recursive Methods in Economic Dynamics. Harvard University Press.

• Woodford, Michael. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.

• Sargent, Thomas J., and Neil Wallace. (1981). "Some Unpleasant Monetarist Arithmetic," Federal Reserve Bank of Minneapolis Quarterly Review, 5(3), 1–17.

Supplementary readings:

• Adda, Jérôme, and Russell Cooper. Dynamic Economics: Quantitative Methods and Applications. Cambridge, MA: MIT Press, 2003.

• An, Sungbae and Schorfheide, Frank. (2007). Bayesian Analysis of DSGE Models. Econometric Reviews, 26(2–4), 113–172.

• Bansal, Ravi, and Amir Yaron. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.” Journal of Finance 59, no. 4 (2004): 1481–1509.

• Campbell, John Y., and John H. Cochrane. “By Force f Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy 107, no. 2 (1999): 205–251.

• Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans. “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy.” Journal of Political Economy 113, no. 1 (2005): 1–45.

• Clarida, Richard, Jordi Galí, and Mark Gertler. “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature 37, no. 4 (1999): 1661–1707.

• Cochrane, John H. Asset Pricing. Rev. ed. Princeton, NJ: Princeton University Press, 2005.

• Cochrane, John H. “Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level.” Econometrica 69, no. 1 (2001): 69–116.

• Cochrane, John H. The Fiscal Theory of the Price Level. Princeton, NJ: Princeton University Press, 2023.

• Galí, Jordi. Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework and Its Applications. 2nd ed. Princeton, NJ: Princeton University Press, 2015.

• Hall, Robert E. “Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence.” Journal of Political Economy 86, no. 6 (1978): 971–87.

• Hansen, Lars Peter and Jagannathan, Ravi. (1991). Implications of Security Market Data for Models of Dynamic Economies. Journal of Political Economy, 99(2), 225–262.

•

Hansen, Lars Peter, and Kenneth J. Singleton. “Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns.” Journal of Political Economy 91, no. 2 (1983): 249–265.

• Lucas, Robert E., Jr. “Asset Prices in an Exchange Economy.” Econometrica 46, no. 6 (1978): 1429–1445.

• Lucas, Robert E., Jr. “Expectations and the Neutrality of Money.” Journal of Economic Theory 4, no. 2 (1972): 103–124.

• Mehra, Rajnish, and Edward C. Prescott. “The Equity Premium: A Puzzle.” Journal of Monetary Economics 15, no. 2 (1985): 145–161.

• Smets, Frank, and Raf Wouters. “Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach.” American Economic Review 97, no. 3 (2007): 586–606.

• Stachurski, John. Economic Dynamics: Theory and Computation. Cambridge, MA: MIT Press, 2009.

• Taylor, John B. “Discretion versus Policy Rules in Practice.” Carnegie-Rochester Conference Series on Public Policy 39 (1993): 195–214.

• Woodford, Michael. “Fiscal Requirements for Price Stability.” Journal of Money, Credit and Banking 33, no. 3 (2001): 669–728.

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