Econ 387: Intermediate Macroeconomic Theory II

Office Hours: 11.30-12.30 Wednesday, WMC 2684 (or by appointment).

TA: Sophie Wang. Office Hours: 11.30-1.20 Monday, WMC 2692. Email: xuefeiw@sfu.ca

Textbook: Macroeconomic Theory and Policy, by D. Andolfatto. Free download available here.

Prerequisites: The course assumes that the student has a working knowledge of basic macroeconomic theory (Econ 305); i.e., Chapters 1-6 in Andolfatto or Chapters 1-8 in Williamson. If you did not take Econ 305 (or its equivalent) using either of these textbooks, then you may have to devote some extra time to catch up on this material. I will spend the first couple of weeks reviewing this core material. As for math requirements, the main tools will be graphs and high-school algebra. Some elementary calculus may be employed as well. While technical skills are important, I will place more emphasis on the ability to grasp economic intuition. You will also be graded on your ability to communicate intuitive ideas in plain written English (sentences that are free of spelling mistakes, are grammatically correct, and use a minimal amount of economic jargon).

Grading: Midterm 1 (15%); Midterm 2 (35%); Final Exam (50%). Note: you have the option of replacing one of the midterm exams with a term paper (due on the last day of classes) in the event that you cannot write a midterm (e.g., illness, etc.) . The topic of the termed paper is to be cleared with me.

Comment Form: Feel free to fill out and hand in comments using this form.

Midterm 1: Thursday, Feb. 9; Midterm 2: Thursday, Mar. 9.

Midterm 1. Answer Key.

Midterm 2. Answer Key.

Lectures

1. Basic Neoclassical Theory I. A basic "static" model that highlights the forces determining the allocation of time across competing activities within a period. Readings: Chapters 1-3. An extension to heterogeneous agents: here.
2. Basic Neoclassical Theory II. A basic "dynamic" model that highlights the forces determining the allocation of resources across time periods. Readings: Chapters 4-6. Extra reading: Economist magazine on the Ricardian Equivalence Theorem [page 1] [page 2].
3. Money, Interest, and Prices, Chapter 8.
4. New-Keynesian Theory, Chapter 9.
5. The Demand for Fiat Money, Chapter 10.
6. International Monetary Systems, Chapter 11.

Tutorial Assignments

• Assignment 1. Information shocks in a business cycle model.
• Assignment 2. Evaluating the economic impact of a child-care subsidy.
• Assignment 3. Interest rates and financial markets.
• Assignment 4. The term structure of interest rates and inflation. Dynamic Yield Curve.

Questions and Answers

1. In our last Econ 387 lecture, we discussed the Neoclassical and Conventional Approach; we touched on the subject of central banks and the wisdom of their governors for knowing more than the average citizen.
   In earlier economic courses, we were told that increasing the money supply is not enough to bring an economy out of a liquidity trap. One can argue that Japan was mired in such an environment during the 90s. But in a famous speech, Mr. Ben Bernanke, the soon to be chair of the Federal Reserves, claimed that dropping money by "helicopters" will get countries out of a liquidity trap.
   How does that work? And where can I get a copy of his speech? I want to read it for myself.
   Thank you.

• Perhaps the speech you are referring to is this one:
  http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
  
  To understand the question being asked, we have to be clear that we understand what is meant by a "liquidity trap."
  
  To begin, note that central banks do not (normally) just print money and inject it willy-nilly to whomever they please (this is the job of the fiscal authority, which is distinct from the monetary authority). Therefore, central banks cannot perform "helicopter drops" of money (printing money and distributing it to people). The way a central bank controls the money supply is through open market operations in the government bond market. Suppose the bank wants to increase the money supply. Then it prints money and uses the money to purchase government bonds. Likewise, if the bank wants to decrease the money supply, it sells government bonds (out of its bond portfolio) and takes in cash.
  
  If one stops to think about the distinction between money and bonds, one realizes that they are basically the same thing, except that bonds usually trade at a discount (i.e., they pay a positive nominal interest rate). In other words, you can think of a $100 bill as a zero-interest government bond.
  
  A liquidity trap refers to a situation where the nominal interest rate (on government bonds) is zero (or close to zero). In this case, if the central bank wants to swap money for bonds, it is just swapping two zero-interest securities that are basically viewed as perfect substitutes in the wealth portfolios of individuals. In other words, if the bank wants to buy my $100 (zero interest) bond with a $100 dollar bill, I really don't care--i.e., I view the two objects as being the same thing (so that such an open market operation has no effect on the economy).
  
  Thus, when the nominal interest rate (on government securities) is close to zero, central banks cannot influence the inflation (or deflation) rate by standard monetary policy procedures. Whether this is a good thing or bad thing is an open question. The conventional wisdom is that it is a bad thing (naturally, since the conventional wisdom really wants to believe that central banks and other government institutions are powerful and can be used for the good of mankind).
  
  Helicopter drops of the type that Bernanke proposes would certainly work to reverse deflation. Such an action, however, is in the realm of the fiscal authority.
  
  Whether deflation is good or bad is an open question. Conventional wisdom views deflation as a bad thing. However, there have been many episodes in history that featured both booming economies under deflation.