Macroeconomics 702 First Year Spring 2016

José-Víctor Ríos-Rull:,

  • Department of Economics University of Pennsylvania. 507 McNeil


  • Mon and Wed 10:30-12:00 McNeil 309. Off Hours: Before and after class and by appointment., email:,

  • TA, Sumedh Ambokar The recitation is on Mondays, Room 395 in McNeil Building from 3.30 pm to 5 pm. His office hours are office hours will be on Tuesdays 1-3 pm in my office room 452.

  • We will have a test on the last day of class. A preview of prelim questions.

  • What are we doing? Brief description of previous classes and next one.

  • Course Description

  • Homeworks and Grades

  • Textbooks

  • Preliminary List of Material to Cover

  • References

  • Problem Sets Problems and solutions with due dates. Do not wait for the posting to answer them.

  • Class notes taken in class and posted by Sumedh. Beware of some typos or other mistakes that are inevitable in these types of notes.

  • What we are doing each day.
    1. March 14.

      I described the course and discussed some context of what are the main facts over which macro has to be organized around:
      1. output per capita has grown at a roughly constant rate
      2. the capital-output ratio (where capital is measured using the perpetual inventory method based on past consumption foregone) has remained roughly constant
      3. the capital-labor ratio has grown at a roughly constant rate equal to the growth rate of output
      4. the wage rate has grown at a roughly constant rate equal to the growth rate of output
      5. the real interest rate has been stationary and, during long periods, roughly constant
      6. labor income as a share of output has remained roughly constant
      7. hours worked per capita have been roughly constant.

      I discussed what restrictions do these facts pose on the models that we use.

      I discussed some of the limitations of this point of view.

      I also discussed what is the meaning of an equilibrium (a mapping from environment to allocations) and then talked about why the social planner problem may be a problem whose solution is interesting (it is because it is the unique equilibrium of the economy once we use the welfare and other theorems). We talked of how an Arrow Debreu Equilibrium for the growth model, supports the social planners solution using the second welfare theorem. I refer to how to build a sequence of markets equilibrium out of an Arrow-Debreu equilibrium (and viceversa) and argue that we can then solve for Social Planner problem sometimes, but that we do so using recursive methods (dynamic programming). Why not then always recursive methods? This is to define equilibria recursively.
    2. March 14 .

      We defined Recursive Competitive Equilibrium. We looked both at rational expectations equilibria and at recursive equilibria with arbitrary expectations.
    3. March 16

      I went over the role of the first welfare theorem (to yield uniqueness). I defined a Markovian stochastic process with finite support. I defined sequence of markets equilibria with complete one period ahead Arrow securities. I defined recursive compet. eq. for a stochastic economy emphasizing market completenes, and state contingent markets to deliver capital.
    4. March 21

      There will be two recitations by Sumedh. He will go over the details of the construction of the Arrow Debreu equilibria from the social planner's solution and also on the equivalence of Arrow Debreu and sequance of markets equilibria.
    5. March 23

      I continued to describe equilibrium of economies where the welfare theorems are of no use. A government financing a public good with lump sum, labor and capital income taxes, and then with debt. We clarified some issues.
    6. March 28

      I described in detail the equilibrium conditions of RCE with debt, especially those that deal with the no Ponzi scheme condition in recursive environments. We view economies with two types of agents in deterministic environments. These agents differ in wealth or skill levels, or there are multiple countries. We did this in deterministic settings.
    7. March 30

      I finished the lstudy of RCE by looking at a stochastic environment with valued leisure with two types of agents that differ in labor efficiency. We went over the Lucas tree economy and we priced trees, state contingent goods and options.
    8. April 4

      We viewed stock returns and the risk free rate. We started looking at search frictions in the goods markets.
    9. April 6

      We finished the discussion of the equilibrium conditions in the Lucas tree with search frictions and competitive search. We started measure theory.
    10. April 11

      We went over measure theory and talked about the meaning of stationary distributions both from the point of view of describing the stochastic properties of a system and for describing heterogeneous objects. w
    11. April 13

      We started Industry Equilibria.
    12. April 18

      We finished Industry Equilibria by looking at an economy with adjustment costs to labor.
    13. April 20

      We started an economy with idyosincratic shocks to household's income and incomplete markets. We reviewed the case of agents that do not trade with each other and the case where agents borrow and lend from each other (The Huggett Economy).
    14. April 25

      We went over the Aiyagari economy where the incomplete markets economy is built on top of a growth model. We then talked about what happens when we are not in a stationary equilibria by talking about transitions and the full recursive equilibria. We made very clear the extent that one can talk about optimality. We also pointed out the usefulness of environments where agents are not fully rational but where being more rational does not pay.
    15. April 27

      We will have a test.

    Course Description.

    This course complements the rest of 702-704. In my view, the ultimate goal of this course is to learn to use a variety of models that can be used to give quantitative answers to economic questions. The models can generate artificial data of both allocations and prices that can be meaningfully related to actual data. In this course most (if not all) of the material will be studied from the strict point of view of the theory, so we will not look at data in any serious manner nor at solving the models with the computer. The emphasis is on economic rigor, i.e. the target is to learn tools that will be useful later. The course, then, is not a survey of topics in macroeconomics. When some specific topic is addressed the objective is not to give a review of known results but rather to give an example of how an issue is addressed and of how tools are used.

    There will be recitations once a week. These will be used either to introduce some mathematical apparatus that we need, to solve homeworks, or to explore issues related to those presented in class. The material covered in recitations constitutes part of the required curriculum.

    Homeworks and Grades

    In the context of the course, I will assign some homeworks: usually I will ask you to prove something during a lecture, sometimes they will be posted in the homepage. These problems are not required but will give you an idea of what is expected for the exams, and especially for the prelim. The grades will be based 30% on a midterm, 60% on a final that will take place the last day of class and 10% on class participation. Sumedh will give you feedback regarding the homeworks. He may post them on the web as well as post answers to it at a later day. Or he may not. We will see about it.

    Textbooks and papers

    No special textbooks. There are notes from previous years and Keyvan may post class notes of this year's class. It never hurts to have the usual suspects, but I do not dwell on them. Besides those used and recommended by my colleagues, there is a good little book (out of print actually) that is useful, Harris, [1987]. The papers that I cite (in a very incomplete form below) are not to be read in general, although some students may find them useful. A fantastic book is being written now by Per Krusell. We will ocassionally use bits of it. First year is to learn tools, not to read papers.

    Preliminary List of Material to Cover

    This list is of material that I want to go over. The first few items you have seen in a very similar way, so I will go very fast over it, but I find it very useful to go over them again.

    1  Introduction

    1.1  Equilibrium. What is its meaning.

    Competitive equilibrium in the growth model. Taking advantage of the welfare theorems.
    Stokey and Lucas, [1989], Chapters 15 and 16; Harris, [1987], Chapters 3 and 4; Cooley and Prescott, [1995].
    A stochastic version of the growth model. What are complete markets? What are one period ahead Arrow-securities? How to define Competitive equilibrium in stochastic growth model.

    1.1.1  Arrow Debreu

    1.1.2  Sequence of Markets

    1.1.3  Recursive Competitive Equilibrium

    2  Recursive Competitive Equilibrium

    2.1  The Basic Setup

    The logic of recursivity. Its principles. How it works when all is easy.

    2.2  A Model with Public Goods

    The first reason that makes life difficult. Non-optimality.

    2.2.1  Financed with Lump Sum Taxation

    2.2.2  Financed with Capital Income Taxation

    2.2.3  Adding Government Debt

    2.3  A Model with Heterogeneous Agents

    The second reason that makes life difficult. Multiple agents. Negishi works but so what?

    2.4  A Model with Uncertainty

    Expanding the model to have shocks.

    2.4.1  Markov Chains

    2.4.2  AD and SM Household Problem

    2.4.3  Recursive Formulation

    2.4.4  Lucas Trees and Asset Pricing

    2.5  A Model with Firms making Investment Decisions

    Separating decision makers.

    2.6  A Model of International Economics

    In multicountry settings people are not country. So what are they?

    3  Measure Theory

    Just counting properly. Any reference is fine.

    4  Industry Equilibrium

    A first notion of production. The sometimes useful of firms as technologies.

    4.1  A static description

    Many firms producing the same.

    4.2  A Simple Dynamic Environment

    They are long lived and still mechanical.

    4.3  Introducing Exit Decision

    Now there is some pruning by choice.

    4.4  Stationary Equilibrium

    What happens in the aggregate. An important theoretical object.

    4.5  Adjustment Costs

    Making firm less silly.

    4.6  What is a firm?

    Let' not fetichize things.

    4.6.1  An entrepreneur

    4.6.2  With some limited liability

    4.6.3  A partnership

    4.6.4  A coalition

    4.6.5  Limits to securitization of corporations

    4.6.6  What about the modern publicly traded corporation

    5  The Aiyagari Economy

    A model with many households using measures to describe them.

    5.1   The household problem

    Bounds when households are impatient.

    5.2   The steady state conditions

    An important notion.

    5.3   Aggregate Shocks

    All things are moving.

    6  Monopolistic Competition

    A detour to get market power.

    7  A Growth Model

    A detour to get economies growing.

    7.1  Exogenous growth

    7.2  Endogenous Growth

    7.2.1  A-K models

    7.2.2  Externalities

    Romer, [1986]

    7.2.3  Two sector growth models

    Lucas, [1988]

    7.2.4  R and D models with monopolistic Competition

    Romer, [1990]

    8  Life Cycle Models

    People do live and die.

    8.1  The Classic trouble making OLG Model

    8.2  A Recursive Formulation for important issues

    9  Search Models

    You can't always get what you want.
    Rogerson, Shimer, and Wright, [2005]

    9.1  The Search Problem

    Should I stay or should I go?

    9.2  A Continuous Time Formulation

    9.3  Generating Transitions

    9.4  Equilibrium

    10  Time Consistent Policy

    Government's commitment is an oxymoron. Then what?

    10.1  A primer. Going against my future self.

    10.2  Sequences of governments.


    COOLEY, T. F., AND E. C. PRESCOTT (1995): "Economic Growth and Business Cycles," in Frontiers of Business Cycle Research, ed. by T. F. Cooley, chap. 1. Princeton University Press, Princeton.
    HARRIS, M. (1987): Dynamic Economic Analysis. Oxford University Press.
    LUCAS, R. E. (1988): "On the Mechanics of Economic Development," 22, 3-42.
    ROGERSON, R., R. SHIMER, AND R. WRIGHT (2005): "Search-Theoretic Models of the Labor Market: A Survey," Journal of Economic Literature, 43, 959-988.
    ROMER, P. M. (1986): "Increasing Return and Long-run Growth," 94, 1002-36.
      (1990): "Endogenous Technological Change," 98, S71-S102.
    STOKEY, N. L., AND E. C. LUCAS, R. E. WITH PRESCOTT (1989): Recursive Methods in Economic Dynamics. Harvard University Press.

    File translated from TEX by TTH, version 3.85.
    On 22 Mar 2013, 8:59.