Macro_Lecture_Notes - Lecture Notes in Macroeconomics John...

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Lecture Notes in Macroeconomics John C. Driscoll Brown University and NBER 1 December 3, 2001 1 Department of Economics, Brown University, Box B, Providence RI 02912. Phone (401) 863-1584, Fax (401) 863-1970, email:John [email protected], web:http: \\ econ.pstc.brown.edu \ jd. c ° Copyright John C. Driscoll, 1999, 2000, 2001. All rights reserved. Do not reproduce without permission. Comments welcome. I especially thank David Weil, on whose notes substantial parts of the chapters on Money and Prices and Investment are based. Kyung Mook Lim and Wataru Miyanaga provided detailed corrections to typographical errors. Several classes of Brown students have provided suggestions and corrections. All remaining errors are mine.
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Contents 1 Money and Prices 1 1.1 De fi nitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1.1 Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1.2 Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2 The History of Money . . . . . . . . . . . . . . . . . . . . . . . . 3 1.3 The Demand for Money . . . . . . . . . . . . . . . . . . . . . . . 4 1.3.1 The Baumol-Tobin Model of Money Demand . . . . . . . 4 1.4 Money in Dynamic General Equilibrium . . . . . . . . . . . . . . 6 1.4.1 Discrete Time . . . . . . . . . . . . . . . . . . . . . . . . . 7 1.4.2 Continuous Time . . . . . . . . . . . . . . . . . . . . . . . 10 1.4.3 Solving the Model . . . . . . . . . . . . . . . . . . . . . . 13 1.5 The optimum quantity of money . . . . . . . . . . . . . . . . . . 14 1.5.1 The Quantity Theory of Money . . . . . . . . . . . . . . . 14 1.6 Seigniorage, Hyperin fl ation and the Cost of In fl ation . . . . . . . 16 1.7 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 2 Nominal Rigidities and Economic Fluctuations 27 2.1 Old Keynesian Economics: The Neoclassical Synthesis . . . . . . 28 2.1.1 Open Economy . . . . . . . . . . . . . . . . . . . . . . . . 31 2.1.2 Aggregate Supply . . . . . . . . . . . . . . . . . . . . . . 33 2.2 Disequilibrium Economics . . . . . . . . . . . . . . . . . . . . . . 36 2.2.1 Setup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2.2.2 The Walrasian Benchmark Case . . . . . . . . . . . . . . 37 2.2.3 Exogenously Fixed Price . . . . . . . . . . . . . . . . . . . 38 2.2.4 Exogenously Fixed Nominal Wage . . . . . . . . . . . . . 39 2.2.5 Both prices and wages in fl exible . . . . . . . . . . . . . . 39 2.2.6 Analysis of this model . . . . . . . . . . . . . . . . . . . . 40 2.3 Imperfect Information Models . . . . . . . . . . . . . . . . . . . . 41 2.4 New Keynesian Models . . . . . . . . . . . . . . . . . . . . . . . . 43 2.4.1 Contracting Models . . . . . . . . . . . . . . . . . . . . . 43 2.4.2 Predetermined Wages . . . . . . . . . . . . . . . . . . . . 44 2.4.3 Fixed Wages . . . . . . . . . . . . . . . . . . . . . . . . . 47 2.5 Imperfect Competition and New Keynesian Economics . . . . . . 50 2.5.1 Macroeconomic E ff ects of Imperfect Competition . . . . . 50 iii
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iv CONTENTS 2.5.2 Imperfect competition and costs of changing prices . . . . 51 2.5.3 Dynamic Models . . . . . . . . . . . . . . . . . . . . . . . 56 2.6 Evidence and New Directions . . . . . . . . . . . . . . . . . . . . 57 2.7 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 3 Macroeconomic Policy 65 3.1 Rules v. Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . 66 3.1.1 The Traditional Case For Rules . . . . . . . . . . . . . . . 66 3.2 The Modern Case For Rules: Time Consistency . . . . . . . . . . 68 3.2.1 Fischer’s Model of the Benevolent, Dissembling Government 68 3.2.2 Monetary Policy and Time Inconsistency . . . . . . . . . 72 3.2.3 Reputation . . . . . . . . . . . . . . . . . . . . . . . . . . 75 3.3 The Lucas Critique . . . . . . . . . . . . . . . . . . . . . . . . . . 77 3.4 Monetarist Arithmetic: Links Between Monetary and Fiscal Policy 79 3.5 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 4 Investment 87 4.1 The Classical Approach . . . . . . . . . . . . . . . . . . . . . . . 87 4.2 Adjustment Costs and Investment: q Theory . . . . . . . . . . . 88 4.2.1 The Housing Market: After Mankiw and Weil and Poterba 91 4.3 Credit Rationing . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 4.4 Investment and Financial Markets . . . . . . . . . . . . . . . . . 95 4.4.1 The E ff ects of Changing Cash fl ow . . . . . . . . . . . . . 97 4.4.2 The Modigliani-Miller Theorem . . . . . . . . . . . . . . . 98 4.5 Banking Issues: Bank Runs, Deposit Insurance and Moral Hazard 99 4.6 Investment Under Uncertainty and Irreversible Investment . . . . 103 4.6.1 Investment Under Uncertainty . . . . . . . . . . . . . . . 107 4.7 Problems: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 5 Unemployment and Coordination Failure 117 5.1 E ciency wages, or why the real wage is too high . . . . . . . . . 117 5.1.1 Solow model . . . . . . . . . . . . . . . . . . . . . . . . . 118 5.1.2 The Shapiro-Stiglitz shirking model . . . . . . . . . . . . 118 5.1.3 Other models of wage rigidity . . . . . . . . . . . . . . . . 120 5.2 Search . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 5.2.1 Setup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 5.2.2 Steady State Equilibrium . . . . . . . . . . . . . . . . . . 122 5.3 Coordination Failure and Aggregate Demand Externalities . . . . 123 5.3.1 Model set-up . . . . . . . . . . . . . . . . . . . . . . . . . 123 5.3.2 Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . 125 5.3.3 De fi
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