In particular, that models be micro-founded is now a clear and not to be discussed requirement. Chapter 1: Economics: The Study of Choice, Chapter 2: Confronting Scarcity: Choices in Production, 2.3 Applications of the Production Possibilities Model, Chapter 4: Applications of Demand and Supply, 4.2 Government Intervention in Market Prices: Price Floors and Price Ceilings, Chapter 5: Macroeconomics: The Big Picture, 5.1 Growth of Real GDP and Business Cycles, Chapter 6: Measuring Total Output and Income, Chapter 7: Aggregate Demand and Aggregate Supply, 7.2 Aggregate Demand and Aggregate Supply: The Long Run and the Short Run, 7.3 Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium, 8.2 Growth and the Long-Run Aggregate Supply Curve, Chapter 9: The Nature and Creation of Money, 9.2 The Banking System and Money Creation, Chapter 10: Financial Markets and the Economy, 10.1 The Bond and Foreign Exchange Markets, 10.2 Demand, Supply, and Equilibrium in the Money Market, 11.1 Monetary Policy in the United States, 11.2 Problems and Controversies of Monetary Policy, 11.3 Monetary Policy and the Equation of Exchange, 12.2 The Use of Fiscal Policy to Stabilize the Economy, Chapter 13: Consumptions and the Aggregate Expenditures Model, 13.1 Determining the Level of Consumption, 13.3 Aggregate Expenditures and Aggregate Demand, Chapter 14: Investment and Economic Activity, Chapter 15: Net Exports and International Finance, 15.1 The International Sector: An Introduction, 16.2 Explaining Inflation–Unemployment Relationships, 16.3 Inflation and Unemployment in the Long Run, Chapter 17: A Brief History of Macroeconomic Thought and Policy, 17.1 The Great Depression and Keynesian Economics, 17.2 Keynesian Economics in the 1960s and 1970s, Chapter 18: Inequality, Poverty, and Discrimination, 19.1 The Nature and Challenge of Economic Development, 19.2 Population Growth and Economic Development, Chapter 20: Socialist Economies in Transition, 20.1 The Theory and Practice of Socialism, 20.3 Economies in Transition: China and Russia, Nonlinear Relationships and Graphs without Numbers, Using Graphs and Charts to Show Values of Variables, Appendix B: Extensions of the Aggregate Expenditures Model, The Aggregate Expenditures Model and Fiscal Policy. While other problems are important, theories concerning them are essentially extensions of theories related to employment. In other words the model is not robust to the Lucas critique. These subdivisions all work together to help inform the global economy. We will use the aggregate demand–aggregate supply model to explain macroeconomic changes during these periods, and we will see how the three major economic schools were affected by these events. 2014. This was, for example, already the case in the Lucas’ (1972) seminal islands model, where agents were already facing a static signal extraction problem. Number of Volumes: 3 Abstract: The 2020 COVID-19 crisis can spur research on firms’ corporate finance decisions and their macroeconomic implications, similar to the wave of important research on banking and household finance triggered by the 2008 financial crisis. The model being solved under the rational expectations hypothesis, expectations are solved consistently with the model. Development of Macroeconomics • The term ‘MACRO’ was first used in economics by RAGNER FRISCH in 1933. Finally, we will see how the evolution of macroeconomic thought and policy influenced how economists design policy prescriptions for dealing with the recession that began in late 2007, which turned out to be the largest since the Great Depression. While the preceding literature essentially focused on the observability of the state of the economy, it is as likely possible to take into account that fact that the agents are uncertain about the model. 2015. Indeed, most financial crises involve a credit crunch, which imply a discrete jump, and hence a non-differentiability in the evolution of credit that perturbation techniques cannot accommodate. Likewise, the degree of price indexation is unlikely to remain invariant to monetary policy. Macroeconomics is the branch of economics concerned with the study of aggregate economic activity. Hansen, Lars Peter and Thomas J. Sargent. One commonly heard argument against the macroeconomic models were their inability to talk about the financial aspects of the business cycle. Remarks on the influence of Edward Prescott. Along with several other economists, he begins work on a radically new approach to macroeconomic thought, one that will challenge Keynes’s view head-on. Macroeconomics is ‘non-experimental’: like, e.g., history, macro-economics cannot conduct controlled scienti fic experiments (people would complain about such experiments, and with a good reason) and focuses on pure observation. What about rationality? Man-Bites-Dog Business Cycles. Early theorists believed that financial factors do not affect real factors, such as the actual output. The Economics of Attention. Departing from the representative agent hypothesis is therefore not a problem anymore. November 8, 2011 November 5, 2011 / Jim Luke. We are then back to the seventies. The implicit information problem was further extended to a full dynamic setting by Collard et al. This is studied by Hansen and Sargent (2007) who adapt robust control techniques to study situations where decision makers acknowledge misspecification in economic modeling. 2007. The Great Recession and the financial crisis in the late 2000s, though, set off another round of controversy. If you are just beginning to learn about economic theory, understanding macroeconomics is the … Even though some areas of macroeconomics have remained more theoretical and mainly deliver qualitative insights on some broad questions, there is now a clear willingness to assess quantitatively the predictions of the models we develop. One would object that, given the signal extraction problems are solved relying on the Kalman filter, this still assumes a lot of cognitive ability on the part of the agents. The development of computers permitted the development of simulation/estimation techniques and promoted the development of new algorithms to solve heterogeneous agent models or models featuring strong non-linearities. The tools Keynes suggested have won widespread acceptance among governments all over the world; the application of expansionary fiscal policy in the United States appears to have been a spectacular success. Does it mean that not much progress has been made? King, Robert G., Charles I. Plosser, and Sergio T. Rebelo. Introduction of Macroeconomics. For example, Boissay et al. In examining the ideas of these schools, we will incorporate concepts such as the potential output and the natural level of employment. The economy has just taken a startling turn: Real GDP has fallen, but inflation has remained high. Is the picture all that rosy? The absence of a satisfactory answer then led to the emergence of the New classical macroeconomics, and the resurgence of equilibrium/flexible price models. Information and the Business Cycle. (2016) develop a model in which banking crises result from the procyclicality of bank balance sheets that emanates from interbank market funding. In other words, as long as the focus is put on the macro-dimension, bringing heterogeneity in the standard model is not critical. At first glance, the representative agent assumption appears to be inconsistent with a serious treatment of micro-foundations. Interestingly, the book adopts a very macroeconomic view of macroeconomics. Models are commonly taken to the data, and their predictions are checked using various econometric and statistical tools. Although simple, this stylized model captures the essence of most DSGE models and appears to contain all ingredients of the Lucasian project. But even more importantly this makes us realize how much we still need to achieve. The Economic Crisis is a Crisis for Economic Theory. Journal of Economic Dynamics and Control, 35(2): 175-252. Finally the model is subject to stochastic shocks that initiate the business cycle. The IS curve corresponds to the aggregation of individual optimal consumption saving arbitrage derived from the maximization of expected lifetime utility subject to the intertemporal budget constraint of the agent. (2015) and Nimark (2014) develop alternative models in which shocks capturing “animal spirits” play a non trivial role. Fiscal Policy in a Tractable Liquidity-constrained Economy. Chapter 17: A Brief History of Macroeconomic Thought and Policy Start Up: Three Revolutions in Macroeconomic Thought. It was an interesting time for economic speculation considering the dramatic adverse effect of the Great Depression. We can think of the macroeconomic history of the 1960s as encompassing two distinct phases. Journal of Monetary Economics, 56(S1): S38-S56. Lucas, Robert E. Jr. 1972. Central to it is the contrast between a Keynesian era and a Lucasian - or dynamic stochastic general equilibrium (DSGE) - era, each ruled by distinct methodological standards. Section 1 of this article analyzes this threefold character of the standard narrative. He counsels a policy of steady money growth, leaving the economy to adjust to long-run equilibrium on its own. Interestingly, 35 years later, the so-called Dynamic Stochastic General Equilibrium (DSGE) models, that are now commonly used in Central Banks to understand and predict the effects of monetary policy decisions, are still built in reference to the Lucas’ project. It is 1970. The time dimension is taken very seriously: models are dynamic (backward-forward looking) and expectations, which play a critical role in modern macroeconomics, receive particular attention. Optimal Sticky Prices under Rational Inattention. ), Handbook of Monetary Economics, Elsevier, Vol. Throughout the book, De Vroey highlights the prominent role played by Robert E. Lucas in the developments of macroeconomics in the last 40 years, not only because he introduced the concept of rational expectations, but even more importantly for macroeconomists because he brought discipline into macroeconomics. In other words, these parameters are not deep, and using these models for policy evaluation purposes can lead to spurious conclusions. • 1945-1970, heyday of Neoclassical Synthesis: Samuelson, Solow, Klein. But, agents actually do not need to be fully informed to take decisions. Their approach proved useful to explain some observed cautious behavior in policy design or solve macro-finance problems (equity premium among others). (Lucas, 2007, 10). This process was accompanied by a greater mathematization of the field, which has borrowed many of the tools from engineering (Kalman filtering, optimal control, dynamic analysis, …) and statistics (Time series econometrics, machine learning, ...). Rational Inattention and Monetary Economics. The history of economics entails numerous figures, courses, and books and can be traced back thousands of years. The first showed the power of Keynesian policies to correct economic difficulties. Challe, Edouard, Julien Matheron, Xavier Ragot, and Juan Rubio-Ramirez. , 2010 and 2011). By making the representative agent assumption, one obviously bypasses this problem. Once the focus is shifted towards redistributive policies or models where heterogeneity affect aggregate level (typically models featuring financial frictions), heterogeneity shall be kept. 2015. The two fundamental behavioral equations, IS and NKP curves, are given explicit micro-foundations. 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