MACROECONOMICS AN INTRODUCTION TO ADVANCED METHODS SCARTH PDF

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This document was uploaded by user and they confirmed that they have the permission to share it. If you are author or own the copyright of this book, please report to us by using this DMCA report form. Report DMCA. Home current Explore. Scarth as PDF for free. Words: , Pages: Preview Full text. No part of the work covered by the copyright hereon may be reproduced or used in any form without written permission. After all, it is stimulating to be involved in the initiation of new research agendas.

But while this activity is exciting for researchers in the field, it can be frustrating for students and their instructors: Journal articles by original researchers rarely represent the best pedagogic treatment of a subject, especially when the analysis bccomes quite technical.

Thus, when the first edition of this text was published 20 years ago, I set out to bridge the gap between intermediate macro texts and the more advanced analysis of graduate school.

But I had a second purpose as well — to draw attention to the work of macroeconomists who have been trying to integrate two quite different schools of thought. On the one hand, there is the rigour and the explicit micro-foundations provided by the New Classical approach, and on the other hand, there is the concern with policy that stems from the Keynesian tradition of focusing on the possibility of market failure. The problem in the s and s was that the Classicals achieved their rigour by excluding market failure, while the Keynesians achieved their supposed policy relevance by excluding explicit micro-foundations.

So both schools of thought were limited in a fundamental way. My earlier editions drew attention to, analyses by macroeconomists who saw the merit in both traditions, and who were, therefore, developing models that could score well on both the criteria for judging model usefulness consistency with empirical observation and consistency with constrained maximization principles.

Happily, this drive toward integration has succeeded. Indeed, the integrated approach has now acquired a title — the "New Neoclassical Synthesis" — and it now occupies centre stage in the discipline. It is high time that a new edition of the book discusses this accomplishment, instead of talking about the desirability of moving toward this goal.

With the increasing use of mathematics in graduate school, virtually all undergraduate programs now offer advanced theory courses, and it has become less appealing to use the same books at both levels.

I have found it best to leave PhD students to be served by the excellent books that now exist for them, and to focus this book on senior undergraduate students and MA students in more applied programs. With this focus, it is appropriate that the book stress policy application, not just the teaching of techniques.

The tradition has been to assume that every student who enrolls in a course at this level is so motivated that no effort is needed to Berri contrast to to the applicability of the ar. Here is a brief introduction to the book's structure Chapter 1 provides a concise summary and extension of intermediate-level macroeconomics. The next three chapters cover the analysis that has emerged to address each of these issues. Chapter 2 examines the First Neoclassical Synthesis — a system that involved the Classical model determining full equilibrium, and a Keynesian model of temporarily sticky prices determining the approach to that full equilibrium.

Chapter 3 gives extensive discussion of the development of rational expectations, and Chapter 4 provides the dynamic optimization analysis that is necessary for models to have a more thorough micro base. The next three chapters cover models that are not so limited, since they incorporate model-consistent expectations and optimization underpinnings.

Chapter 5 covers the first school of thought to stress the desirability of keeping these features central — real business cycle theory.

Then, with temporary nominal rigidity added to a simplified New Classical model, Chapters 6 and 7 explain both the methods needed to analyze the New Neoclassical Synthesis, and the success we have had in applying this approach to a set of central policy issues. The book shifts to long-run issues for the final five chapters. Chapters 8 and 9 focus on theory and policy issues concerning the natural unemployment rate, while Chapters 10, 11 and 12 discuss both old and new growth theory.

With the chapters on micro-foundations, New Classical work, labour markets, and growth, more than half of this edition is focused on the long run. Using basic mathematics throughout, the book introduces readers to the actual research methods of macroeconomics.

But in addition to explaining methods, it discusses the underlying logic at the intuitive level, and with an eye to both the historical development of the subject, and the ability to apply the analysis to applied policy debates.

Concerning application, some of the highlighted topics are: the Lucas critique of standard methods for evaluating policy, credibility and dynamic consistency issues in policy design, the sustainability of rising debt levels and an evaluation of Europe's Stability Pact, the optimal inflation rate, the implications of alternative monetary policies for pursuing price stability price-level vs inflation-rate targeting, fixed vs flexible exchange rates , tax reform trickle-down controversies and whether second-best initial conditions ease the trade-off between efficiency and equity objectives , theories of the natural unemployment rate and the possibility of multiple equilibria, alternative low-income support policies, and globalization including the alleged threat to the scope for independent macro policy.

In earlier editions, I have thanked some of my mentors — individuals who have been instrumental in my own development. In this edition, I confine my acknowledgements to two groups — those who have provided helpful discussion concerning particular topics, and some impressive students who have helped improve earlier drafts.

It should, of course, be emphasized that none of these individuals can be held responsible for how I may have filtered their remarks. Despite the real contributions of these individuals, my greatest debt is to my wife, Kathy, whose unfailing love and support have been invaluable. Without this support I would have been unable to work at making the exciting developments in modern macroeconomics more accessible.

Okun's Gap 5. Flexible Exchange Rates 7. Nominal Rigidities 8. Indirect Taxation 9. One purpose of this book is to examine some of these controversies, to draw attention to developments — that have led to a important synthesis of mpoant ideas from both traditions, and to illustrate in some detail how this integrated approach can inform policy debates. At the policy level, the hallmarks of Keynesian analysis are that involuntary unemployment can exist and that, without government assistance, any adjustment of the system back to the "natural" unemployment rate is likely to be slow and to involve cycles and overshoots.

In its extreme form, the Keynesian view is that adjustment back to equilibrium simply does not take place without policy assistance. This view can be defended by maintaining either of the following positions: i the economy has multiple equilibria, only one of which involves "full" employment; or ii there is only one equilibrium, and it involves "full" employment, but the economic system is unstable without the assistance of policy, so it cannot reach the "full" employment equilibrium on its own.

We shall consider the issue of multiple equilibria in Chapter 9. In earlier chapters, we focus on the question of convergence to a full equilibrium. To simplify the exposition, we concentrate on stability versus outright instability, which is the extreme form of the issue. We interpret any tendency toward outright instability as analytical support for the more general proposition that adjustment between full equilibria is protracted.

In this first chapter, we examine alternative specifications of the labour market, such as perfectly flexible money wages the textbook Classical model and completely fixed money wages the textbook Keynesian model , to clarify some of the causes of unemployment.

We consider fixed goods prices as well the model of generalized disequilibrium , and then we build on this background in later chapters. For example, in Chapter 2, we assume that nominal rigidities are only temporary, and we consider a dynamic analysis that has Classical 1 properties in full equilibrium, but Keynesian features in the transitional periods on the way to full equilibrium.

Fifty years ago, Paul Samuelson labelled this class of dynamic models the Neoclassical Synthesis. In Chapter 3, we enrich this dynamic analysis by exploring alternative ways of bringing expectations into the analysis. With expectations involved, it is not obvious that an increased degree of price flexibility lessens the amount of cyclical unemployment that follows from a decrease in aggregate demand.

By the end of Chapter 3, we will have identified two important considerations that make macroeconomic convergence more problematic: firms' reactions to sticky prices and sales constraints, and expectations. In Chapter 4, we rectify one major limitation of the analysis to that point — that formal micro-foundations have been missing. The intertemporal optimization that is needed to overcome this limitation is explained in Chapter 4. Then, in Chapter 5, we examine the New Classical approach to business cycle analysis — the modern, more micro-based version of the market-clearing approach to macroeconomics, in which no appeal to sticky prices is involved.

Finally, in Chapters 6 and 7, we examine what has been called the "New" Neoclassical Synthesis — a business-cycle analysis that blends the microeconomic rigour of the New Classicals with the empirical applicability that has always been the focus of the Keynesian tradition and the original Neoclassical Synthesis. For the remainder of the book the final five chapters , the focus shifts from short-run stabilization issues to concerns about long-run living standards.

In these chapters, we focus on structural unemployment and the challenge of raising productivity growth. First, models must be subjected to empirical tests, to see whether the predictions are consistent with actual experience.

This criterion is fundamentally important. Unfortunately, however, it cannot be the only one for model selection, since empirical tests are often not definitive. Thus, while progress has been made in dev'eloping applied methods, macroeconomists have no choice but to put at least some weight on a second criterion for model evaluation. Since the hypothesis of constrained maximization is at the core of our discipline, all modern macroeconomists agree that macro models should be evaluated as to their consistency with optimizing underpinnings.

Without a microeconomic base, there is no well defined basis for arguing 2 that either an ongoing stabilization policy, or an increase in the average growth rate, improves welfare. Increasingly, Keynesians have realized that they must acknowledge this point. Further, the challenge posed by New Classicals has forced Keynesians to admit that it is utility and production functions that are independent of government policy; agents' decision rules do not necessarily remain invariant to shifts in policy.

A specific microeconomic base is required to derive how private decision rules may be adjusted in the face of major changes in policy. Another advantage is that a specific microeconomic rationale imposes more structure on macro models, so the corresponding empirical work involves fewer "free" parameters parameters that are not constrained by theoretical considerations and can thus take on whatever value will maximize the fit of the model.

It must be admitted that the empirical success of a model is compromised if the estimation involves many free parameters. Despite these clear advantages of an explicit microeconomic base, those who typically stress these points — the New Classicals — have had to make some acknowledgments too.

They have had to admit that, until recently, their models have been inconsistent with several important empirical regularities. As a result, they, like Keynesians, now allow for some temporary stickiness in nominal variables.

Also, since the primary goal of this school of thought is to eliminate arbitrary assumptions, its followers cannot downplay the significance of aggregation issues or of the non-uniqueness problem that often plagues the solution of their models. These issues have yet to be resolved in a satisfactory manner.

During the s and s, controversy between New Classicals and Keynesians was frustrating for students. Each group focused on the advantages of its own approach, and tended to ignore the legitimate criticisms offered by the "other side. In the s however, there was an increased willingness on the part of macroeconomists to combine the best features of the competing approaches so that now the subject is empirically applicable, has solid micro-foundations, and it allows for market failure — so economic policy can be explored in a rigorous fashion.

Students can now explore models that combine the rigour of the New Classicals with the policy concern that preoccupies Keynesians. The purpose of any model is to provide answers to a series of ifthen questions: if one assumes a specified change in the values of the exogenous variables those determined outside of the model , what will happen to the set of endogenous variables those determined within the model?

A high degree of simultaneity seems to exist among the main endogenous variables for example, household behaviour makes 3 consumption depend on income, while the goods market-clearing condition makes income depend on consumption. To cope with this simultaneity, we define macro models in the form of systems of equations for which standard solution techniques either algebraic or geometric can be employed.

A model comprises a set of structural equations, that are either definitions, equilibrium conditions, or behavioral reaction functions assumed on behalf of agents. The textbook Classical model, the textbook Keynesian model, and the "more Keynesian" model of generalized disequilibrium all summarized graphically in later sections of this chapter; are standard examples. In constructing these models, macroeconomists have disciplined their selection of alternative behavioural rules by appealing to microeconomic models of households and firms.

In other words, their basis for choosing structural equations is constrained maximization at the individual level, without much concern for problems of aggregation. To keep the analysis manageable, macroeconomists sometimes restrict attention to particular components of the macroeconomy, considered one at a time.

They record the resulting decision rules the consumption function, the investment function, the money-demand function, the Phillips curve, and so on, which are the first-order conditions of the constrained maximizations as a list of structural equations. This series of equations is then brought together for solving as a standard set of simultaneous equations in which the unknowns are the endogenous variables.

In other words, the procedure has two stages: Stage 1: Derive the structural equations, which define the macro model, by presenting a set of sometimes unconnected constrained maximization exercises that is, define and solve a set of microeconomic problems.

Stage 2: Use the set of structural equations to derive the solution or reduced form equations in which each endogenous variable is related explicitly to nothing but exogenous variables and parameters and perform the counterfactual exercises for example, derivation of the policy multipliers. Before , macroeconomics developed in a fairly orderly way, following this two-stage approach.

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