NEKG41-Macroeconomic Analysis

Course Structure

• Practice sessions after lectures 6 & 9.
• Examination: a total of 40 points.
  • Written assignment: 7 points.
  • Peer review: 3 points.
  • Exercises: 2 points.
  • Final exam: 28 points.
• Final exam: essay on a given topic.
• Deadlines:
  • Written assignment: 1 Dec.
  • Peer review: 7 Dec.
  • Final exam: 14 Dec (14-21).

Introduction: Macroeconomic Models

Why Models?

• Political action often has conflicting effects, e.g.
  • Regulation reduces crisis risk ➔ increases production.
  • Decreased consumption and investment ➔ decreases production.
• Evaluation of which effect is stronger is needed.

DSGE (Dynamic Stochastic General Equilibrium)

• Dominant paradigm in quantitative macroeconomics.
• Criticised after the financial crisis of 2008.
• Exogenous shocks affect the economy.
• Focus on general equilibrium.

Lucas Critique 1976

• Estimated parameters are not policy-invariant.
• DSGE models were developed in response.

Summary of Economic Models

• Simplifies complex worlds and avoids oversimplification.
• Numerical answers and mechanisms explained.
• Important to understand limitations.

Lecture 1: Labour and Goods Market

Work and Leisure

• Keyne's prediction of a 15-hour workweek by 2030.
• Reality shows greater income disparities and incentives lead to more worked hours.

Long-term Equilibrium in the Labour Market

• Real Wage (W) and Labour Supply (L) relations.
• Consumption-leisure trade-off for households.
• Labour supply is often upward sloping, but exceptions exist.

Labour Demand

• Companies maximise profit.
• Example of shocks: Brexit affects wages and labour supply.

Unemployment

• Created by union negotiations and contracts.
• Dynamic unemployment model: frictional unemployment and structural unemployment.

Lecture 2: Money

Deflation and Monetary Policy

• Deflation can confuse policymakers.
• Types of deflation: bad, good, ugly deflation.

Money Neutrality

• In the long term, the money supply does not affect the real economy.

Inflation

• Measurement methods: GDP deflator and Consumer Price Index.
• Hyperinflation and low inflation.

Exchange Rates

• Nominal and real exchange rates.
• Purchasing Power Parity (PPP) and its implications.

Lecture 3: Budget Constraints and Private Sector Demand

Intertemporal Budget Constraints

• Lump-sum tax does not affect behaviour or wealth.
• Different types of rationality, expectations, and discounting.

Ricardian Equivalence

• Does not hold in reality due to reasons like different interest rates and heterogeneous agents.

Life Cycle Consumption Theory

• Temporary versus permanent income change.

Investment and Interest

• Investment is inversely related to interest rate.
• Tobin's Q: relation between firm market value and replacement cost of capital.

Lecture 4: Money, Banks and Monetary Policy

What is Money?

• Definitions and types of money: commodity money, fiat money, inside and outside money.

Commercial Banks

• Create money through lending and liquidity services.

Central Bank

• Public authority with the mandate to control the money supply.

Money Supply

• Measures: M0, M1, M2, M3.
• Modern approach: Banks create money through lending.

Monetary Policy and Financial Stability

• Inflation targets, Taylor rule and crisis management.

Lecture 5: Macroeconomic Equilibrium

IS-LM Model

• Focuses on short-term disturbances in goods and money markets.

Net Exports

• Affected by income and exchange rate.

Multiplier Effects

• Keynesian multiplier: impact of autonomous spending increase.

Lecture 6: Mundell-Fleming Model

Foreign Exchange Market Equilibrium

• Governed by interest rate parity conditions.

Policy Trilemma

• Choice of interest rate policy or exchange rate.

Lecture 7: Aggregate Supply

Phillips Curve

• Negative relationship between unemployment and inflation.

Neoclassical Synthesis

• Long-term model with self-adjustment after shocks.

Lecture 8: Aggregate Demand

Demand Shocks

• Government policy most effective in fixed exchange rate regime.

Lecture 9: AS/AD Model

AD Curve Shifts

• Affected by expenditure shocks and interest rate changes.

Aggregate Supply Shock

• Troublesome for policymakers.

Lecture 10: Demand Policy

Business Cycles

• Periodic fluctuations around long-term growth paths.

Demand Management Policy

• Problems with political cycles and policy delays.

Lecture 11: Fiscal Policy

Demand Management Policy

• Budget balance and indebtedness.

Debt Stabilisation

• Short-term and long-term solutions for debt level reduction.

These notes cover the central concepts and models presented in the lecture. They provide an overview of macroeconomic analysis of models, labour and goods markets, money and banks, and economic policy and their impact on business cycles and debt.