Intermediate Macroeconomics
Introduction
Jean Imbs
NYUAD
1/37
Textbook Readings
Romer,(Today:Introduction)
Chiang and Wainwright,Chapters 15 (selective).
Mankiw,(Today:Chapter 1)
2/37
Introduction
Aims and Objectives:Object of Inquiry
Broadly speaking,macroeconomics is interested in the
aggregate economy of a nation
Described by a series of aggregate variables such as GDP,
Consumption,Investment,Interest Rates,Ination etc.
These variables are typically catalogued for a nation in their
National Income and Product Accounts (NIPA)
An excellent data source for the U.S.is the FRED database,
free online,at the Federal Reserve Bank (St.Louis)s website
The object of inquiry,the aggregate economy,described by
aggregate variables,demonstrates certain empirical regularities,
motivating the study of the macroeconomics
3/37
Introduction
Aims and Objectives:Questions
The main aims of macroeconomics have to do with (i)
economic growth and (ii) cycles,as measured by various
statistical representations of the variables that describe the
economy
Economic Growth:challenges are to identify economic
processes that allow nations to exhibit long run growth in
percapita income (GDP),and why GDP growth rates across
nations vary
Business Cycles:challenges are to explain and predict the
myriad uctuations exhibited in the short run by a large
number of aggregate variables around a given growth rate
4/37
Introduction
Aims and Objectives:Methodology
However,there is a unifying methodological theme for
analyses of growth and cycles
The explanation of necessarily dynamic phenomena with
Dynamic (Deterministic or Stochastic) General Equilibrium
models
The models are then evaluated using statistical techniques to
determine the extent to which they match data and thereby
could be employed in policy making and/or forecasting
No model is perfect,the idea is to examine the extent to
which a model can be used
5/37
Introduction
Aims and Objectives
A Brief Modern History of Macroeconomic Thought
The Traditional Approach for studying empirical regularities
Began with the specication of a (static or dynamic) system
of equations consisting of accounting identities,adhoc
behavioral equations (e.g.,the consumption function) and
forcing processesfor exogenous variables
Two main theoretical paradigms that each gave a system for
analysis:Classical and Keynesian
Classical:markets comprising an aggregate economy
equilibrated through smooth relative price adjustments and
posited a realnominal dichotomy
Keynesian:did away with market clearing assumptions
(especially in the shortrun),and explained why nominal and
real variables inuenced one another
Regardless of paradigm,the method of analysis,theoretical or
empirical,was the same:specication of a system of equations
reecting views on the interaction of aggregate variables.
6/37
Introduction
Aims and Objectives
The Modern Approach for studying empirical regularities
Requires construction of explicit dynamic (possibly stochastic)
optimization problems facing agents interacting in a general
equilibrium
Dynamic:because macroeconomic variables time series exhibit
persistence(e.g.yesterdays value of GDP is related to
todays value) we must account for the notion that economic
decisions made today will a¤ect at the very least the set of
choices tomorrow.
Optimization problems consistent with microeconomic
principles,endogenous variables clearly identied relative to
exogenous and predetermined ones
Expectations of variables consistent with the model at hand
Result:a system of equations with no adhoc behavioral
equations,but equations that explicitly reect economic
behavior of agents within and across time
7/37
Introduction
Aims and Objectives
Change in methods applied to all paradigms,giving birth to
New Classical and New Keynesian schools of thought
operating under new methodological principles:clear
specication of preferences,constraints,policies and external
factors that yield a system of equations with a direct link to
optimization problems facing agents
8/37
Introduction
Aims and Objectives
Modern macroeconomics employs economic models to achieve
mostly one of three major goals
Account for (often via replication),recurrent patterns of
aggregate economic activity known as stylized facts
These facts pertain to long run growth rates of
macroeconomic aggregates as well as characteristics of their
short run (often dened as quarterly) cyclical uctuations
Interpret and analyze specic aggregate socioeconomic
episodes,e.g.the worldwide Great Depression of the 1930s
Conduct policy analyses that cannot be conducted in reality
E.g.,what would be the societal welfare implications of the
U.S.economy eschewing income taxes in favor of only sales
taxes?
Such a question cannot be experimented with in reality but
can be analyzed using a model of aggregate economic
behavior.
9/37
Introduction
A Tour of Topics and Tools
Time Series Data:in growth and cycle models,
macroeconomists employ time series data
A time series represents the value of a variable (e.g.real GDP,
say y) over time
Thus denote a time series as a function of time,e.g.y(t) = y
t
because as time changes the value of real GDP changes
Next,work with logged versions of a time series represented in
levels
This is because changes in the log of a variable y
t
over time
represent the growth rate of the variable
d log y(t)
dt
=
d log y
t
dt
=
dey
t
dt
=
dy
t
dt
y
t
y
t
y
t
g
y
t
(1)
where
y
t
=
dy
t
dt
.
10/37
Introduction
A Tour of Topics and Tools
Growth models try to explain pattern of g
y
t
within and across
countries
As an example of growth for one country,consider U.S.Real
Gross Domestic Product
GDPC96 in FRED database
Time series plots:
In trillions of 2000 dollars (y
t
)
In natural logarithms (log y
t
)
11/37
Introduction
U.S.Real GDP
12/37
Introduction
Natural Logarithm of U.S.Real GDP
13/37
Introduction
A Tour of Topics and Tools
Business cycle models try to explain uctuations in time series
variables around their trends
As an example,nominal GDP (Y
t
) for the U.S.can be
thought of as the real GDP (y
t
) multiplied by some measure
of the aggregate price level (p
t
)
Y
t
= p
t
y
t
(2)
Let us look at those two components separately (i.e.
uctuations in real GDP and a measure of ination)
Consider the GDP implicit price deator as a measure of the
aggregate price level (p
t
),GDPDEF in FRED database
14/37
Introduction
A Tour of Topics and Tools
Time series plots of cycles:
Consider uctuations around the growth rate in terms of
annualized percentage change in y
t
by
t
=
("
y
t
y
t1
4
#
1
)
100 (3)
And consider ination (bπ
t
) measured as the annualized
percentage change in p
t
b
π
t
=
("
p
t
p
t1
4
#
1
)
100 (4)
15/37
Introduction
Annualized Percentage Change in U.S.Real GDP
16/37
Introduction
Annualized Percentage Change in U.S.Real GDP Deator (Ination)
17/37
Introduction
A Tour of Topics and Tools
Select Stylized Facts for Macroeconomic Environments:
Growth
Balanced Growth:
In the long run (measured on a veyear basis) output and
physical capital per worker grow at almost constant rates that
show no diminishing
Physical capital to output ratio and the rate of return to
capital are almost constant quantities
Return to labor (wages) grows at the same rate as output;
output shares of capital and labor are almost constant
Crosscountry di¤erences in levels and growth rates of GDP:
Persistent Di¤erences:unconditional convergence of poor
countries to rich ones is nonexistent
But,groups of countries that share characteristics show
convergence,called conditional convergence
18/37
Introduction
A Tour of Topics and Tools
Select Stylized Facts for Macroeconomic Environments:Cycles
Business cycles are dened as the deviation of real GDP from
itstrend.Business cycle facts are reported in terms of
Volatility:the standard deviation of a variable relative to the
standard deviation of real GDP.
Comovement:correlation of the variable with other variables.
Persistence:correlation of the variable with itsown past
lagged values.
These facts can be
Procyclical,Countercyclical or Acyclical
Leading,Coincident or Lagging
19/37
Introduction
Real Stylized Facts
Consumption of nondurables and services is less volatile than
real output.
Investment is three times as volatile than real output.
Hours worked are much less volatile than output.
20/37
Growth rates of real GDP, consumption
10
RlGDP
8
10
Percent
change
from 4
R
ea
l
GDP
growth rate
Consumption
6
quarters
earlier
Consumption
growth rate
2
4
Average
growth
rate
0
2
rate
2
4
197019751980198519901995200020052010
Growth rates of real GDP, consumption, investment
30
40
Percent
change
from 4
Investment
growth rate
20
30
quarters
earlier
RlGDP
10
R
ea
l
GDP
growth rate
10
0
Consumption
g
r
o
w
t
h r
ate
20
gotate
30
197019751980198519901995200020052010
Index of Leading Economic Indicators
Published monthly by the Conference Board.
Aims to forecast changes in economic activity
69 months into the future.
Used in planning by businesses and govt,
despite not being a perfect predictor.
Components of the LEI index
Average workweek in manufacturing
Initialweeklyclaimsforunemploymentinsurance
Initial
weekly
claims
for
unemployment
insurance
New orders for consumer goods and materials
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乥N
潲摥牳
Ⱐ
湯湤敦敮獥
捡灩瑡c
杯潤g
Vendor performance
乥N扵楬摩湧灥牭楴p楳獵敤
乥N
扵楬摩湧
灥牭楴p
楳獵敤
Index of stock prices
䴲
䴲
Yield spread (10year minus 3month) on Treasuries
䥮摥I潦捯湳畭敲數灥捴慴楯湳
䥮摥I
潦
捯湳畭敲
數灥捴慴楯湳
Index of Leading Economic Indicators
110
120
00
90
100
004 = 1
70
80
2
50
60
70
40
50
Source:
Conference
Board
30
197019751980198519901995200020052010
Introduction
Nominal Stylized Facts
Money growth is leading and procyclical.
Ination is leading and procyclical.
Nominal interest rates are lagging and procyclical.
Stock prices are leading and procyclical.
21/37
Introduction
Elements of General Equilibrium
General Equilibrium
Most macroeconomic environments are applied general
equilibrium models
You will learn the exact meaning of General Equilibrium (GE)
as you go through the core microeconomic theory and
macroeconomic theory sequence of courses at NYUAD
Su¢ ce it to say for now that GE e¤ectively refers to
accounting simultaneously for all of the optimization
objectives of the agents comprising the aggregate economy;
clearly specifying the economic environment they operate in
(e.g.market clearing) as well as specifying what the
researcher is taking as exogenous to the environment (e.g.
shocks to an economy like Hurricane Katrina)
We will basically learn what dynamic GE models are
throughout this course,so by the end of this course,you
should be well versed in these models
22/37
Introduction
A Graphical Example of a GE
23/37
Introduction
Elements of General Equilibrium
Typically in macroeconomic environments agents are:
Households who maximize utility from consumption and leisure
subject to budget constraints that may be dynamic in nature
Firms who maximize prot from selling output subject to the
constraint that they can produce only so much given a level of
available factors of production (i.e.production function)
Governments who (hopefully) maximize some welfare criterion
for the good of (hopefully) all citizens
Economic aspects of the environment typically consist of how
households and rms interact and assumptions on the nature
of the functioning of markets (e.g.do markets clear?and if so
at what relative price sequences?)
In order for a GE model to be precise and be amenable for
empirical evaluation we have to allow for various functional
forms for utility and production
24/37
Introduction
Elements of General Equilibrium:Some Welfare FYI
Under certain conditions,the economic outcomes of general
equilibrium models have certain attractive e¢ ciency
properties,captured by the socalled Fundamental Welfare
Theorem.
The rst theorem states that if markets are competitive and
complete,then equilibrium prices will ensure that the
allocation of goods to the households is Pareto e¢ cient.
This means that,under the current equilibrium allocation,it is
not possible to make some household better o¤ without
making another worse o¤.
A market can be described as competitive if each economic
agent,while optimizing her own objective,takes prices as a
given.
We say that markets are complete when a market exists for all
possible goods and contingencies.
The rst welfare theorem is the most important.
25/37
Introduction
Elements of General Equilibrium:Some Welfare FYI
The second theorem implies that any allocation of goods and
services that is Pareto e¢ cient can be implemented as a
competitive equilibrium.
For example,suppose that society considers a particular
(Pareto e¢ cient) outcome to be socially desirable.
Then the second welfare theorem says that the government
can devise a lumpsum tax and transfer system of endowments
that can implement it.
The rst welfare theorem is easily the more immediately
relevant of the two as it allows macroeconomists to model a
theoretical social planner instead of multiple markets.
We will learn intuitively what these welfare theorems mean as
we go through the material in this course.
26/37
Introduction
Summary and Notes
The textbook will only be followed loosely.That is,these
notes are going to be fundamental.But you need to be
reading the book as well.
Exams will cover these notes and the textbook.
Interactive participation will be critical.
27/37
Data Review
Key time series data we will want to model:
Nominal GDP (P
t
Y
t
)
Real GDP (Y
t
) (Value Added)
Aggregate Prices (P
t
) via the GDP Deator and the CPI
Unemployment Rate
28/37
Data Review
GDP
Two denitions:
Total expenditure on domesticallyproduced nal goods and
services.
Total income earned by domesticallylocated factors of
production.
Key:Expenditure equals income because every dollar spent by
a buyer becomes income to the seller.
Hence the circular ow of income and
Y
t
{z}
Income
= C
t
+I
t
+G
t
+X
t
M
t

{z
}
Expenditure
(5)
Note:GNP GDP = factor payments from abroad minus
factor payments to abroad.
29/37
Data Review
GDP and Value Added
Value added:The value of output minus the value of the
intermediate goods used to produce that output
GDP = value of nal goods produced = sum of value added
at all stages of production.
The value of the nal goods already includes the value of the
intermediate goods,so including intermediate and nal goods
in GDP would be doublecounting.
30/37
Data Review
GDP:Expenditure Side
Consumption (C
t
):The value of all durable goods,
nondurable goods and services bought by households.
Investment (I
t
):Spending on good bought for future use (e.g.
capital goods).Includes:Business xed invesment (e.g.
equipment),Residential xed investment,Inventory
investment.Basically is spending on new capital that comes
online as capital (K
t
) in the future.
I
t
is a ow,K
t
is a stock so in discrete time
K
t+1
= I
t
+(1 δ)K
t
,δ 2 (0,1) (6)
31/37
Data Review
GDP:Expenditure Side
Government Spending (G
t
):includes all government spending
on goods and services.Excludes transfer payments (e.g.,
unemployment insurance payments),because they do not
represent spending on goods and services.
32/37
Data Review
Measuring Prices
GDP is the value of all nal goods and services produced.
Nominal GDP measures these values using current prices.
Real GDP measure these values using the prices of a base year.
So changes in Nominal GDP could because of uctuations in
P
t
or Y
t
But,changes in Real GDP can only be due to changes in Y
t
.
Hence
P
t
= GDP Deator = 100
Nominal GDP
Real GDP
(7)
33/37
Data Review
Measuring Prices
The GDP Deator at time t for n goods usually measured as
P
t
=
Nominal GDP
t
Real GDP
t
(8)
=
P
1t
Q
1t
+...+P
nt
Q
nt
Real GDP
t
(9)
=
Q
1t
Real GDP
t
P
1t
+...+
Q
nt
Real GDP
t
P
nt
(10)
34/37
Data Review
Measuring Prices
Thus,The GDP deator is a weighted average of prices.The
weight on each price reects that goods relative importance
in GDP.Note that the weights change over time.
In a CPI computation the weights remain (more or less) xed
over time.
Thus as macroeconomists the GDP Deator (P
t
) is a better
measure of aggregate prices because the CPI can overstate
ination.
35/37
Data Review
Measuring Prices
CPI can overstate ination because of:
Substitution bias:The CPI uses (almost) xed weights,so it
cannot reect consumersability to substitute toward goods
whose relative prices have fallen.
Introduction of new goods:The introduction of new goods
makes consumers better o¤ and,in e¤ect,increases the real
value of the dollar.But it does not reduce the CPI,because
the CPI uses (almost) xed weights.
Unmeasured changes in quality:Quality improvements increase
the value of the dollar,but are often not fully measured.
Also,the prices of capital goods are included in the GDP
deator but not in the CPI;the prices of imported goods are
included in the CPI but not in the GDP deator.
36/37
Data Review
Measuring Unemployment
Categories of Labor:
Employed:working at a paid job
Unemployed:not employed but looking for a job
Labor force:the amount of labor available for producing goods
and services;all employed plus unemployed persons
Not in the labor force:not employed,not looking for work
Unemployment rate:percentage of the labor force that is
unemployed
Labor force participation rate:the fraction of the adult
population that participatesin the labor force
Okuns Law:the negative relationship between GDP and
unemployment.
37/37
Unemployment
12
10
12
Percent
of labor
force
8
6
4
2
0
197019751980198519901995200020052010
Okun’sLaw
Percentage
change in
realGDP
8
10
32
Y
u
Y
1951
1966
real
GDP
6
1984
2003
2
4
1987
2008
1971
0
2
1975
2001
4
2
1982
1991
Change in unemployment rate

4
32101234
Index of Leading Economic Indicators
Published monthly by the Conference Board.
Aims to forecast changes in economic activity
69 months into the future.
Used in planning by businesses and govt,
despite not being a perfect predictor.
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