Econ 208

Marek KapickaLecture 1

Introduction

What is this course about? Analysis of macroeconomic policies

Government Spending Taxation and government debt Monetary policy Banking and financial intermediation

We will use micro-founded macroeconomic models to study those issues

Administration

Classes: MW 9:30-10:45 My email:

mkapicka@econ.ucsb.edu Office hours: TTh 10:30-11:30, NH

3052 Course homepage:

http://econ.ucsb.edu/~mkapicka/E208.html

Administration

TAXintong Yang (lemon0215@gmail.com)TA sessions: Thursdays 3:00-3:50 & 4:00-

4:50 GIRV 1116

TextbookMacroeconomics, by Matthias Doepke,

Andreas Lehnert, and Andrew Sellgren

Administration 5 problem sets

4 best ones count25 % of the final grade

Midterm (May 6, in class)No make-up25 % of the final gradeClosed book, closed notes

Final (June 12, 9-11)50 % of the final gradeClosed book, closed notes

Outline of the course

1. Introduction: A basic framework2. Government Policies

1. The Effects of Government Spending2. Government Taxation and

Government Debt3. Monetary Policy4. Banking and Financial

Intermediation

Per Capita Real GDP (in 2000 dollars) for the United States, 1900-2008

Growth rates

If gt is small,

11

t

tt y

yg

1lnln)1ln( tttt yygg

Natural Logarithm of Per Capita Real GDP

The Great Recession

1981-1982 Recession

1. US GDP, Consumption, and Government Expenditures

2. Total Taxes (black line) and Total Government Spending (colored line) in the United States, as Percentages of GDP

2. Recent Recession: Fiscal Policy

2009 Fiscal Stimulus: $787 billion (~5.5% of GDP)

Tax cuts: $288 billion Spending on

Healthcare & Education: $238 billion Infrastructure: $81 billion

4. US History of banking crises

Before 1914: Crises were a frequent phenomenon in the U.S.

National banking era 1863-1913 They have occurred at about 10

year intervals 1873,1884,1890,1893,1896,1907,191

4

U.S. National Banking Era Panics

2. How do we study macro? We cannot run experiments in

macroeconomics, so we need to construct models to be used as laboratories

Prague

A map of Prague

A map of Prague subway

How do we study macro? A good model:

Simplified, abstract, representation of reality

Omits many details, represents only essential features needed to answer a specific question

helpful to make predictions should be simple, but they need not

be realistic.

2.1 Structure of a typical model

HouseholdsChoose consumption,saving, labor supply

FirmsChoose production,

investment, labor demand

MarketsPrices such that

Supply = demand

2.1 Structure of a typical model

1. Description of goods in the economy

2. Consumers preferences over goods

3. Firms technology available to produce the

goods

4. The resources available

2.2 Prediction of a Model

Individual behavior people behave rationally (optimize) firms maximize profits

Equilibrium behavior competitive equilibrium

2.3 Microeconomic Foundations

The Approach1. Start with consumers and firms

making decisions at individual level2. Aggregate them up

Representative Consumer Assumption

Example: Benefits of this Approach

1. Monetary Policy

A Basic Intertemporal Model

A simple model where people

choose how much to consume and

how much to save A) Consumer Optimization B) Market Clearing C) Adding capital stock D) Welfare Theorems E) Infinite horizon

A Basic Intertemporal Model

First period = current period Second period = future period

To simplify, abstract from labor/leisure decision

Our interest: borrowing and saving by consumers

A Basic Intertemporal Model Preferences of consumers

U(c) is increasing, differentiable and concave

Discount factor β<1 measures how much future utility matters relative to current utility

)()( 21 cUcU

A Basic Intertemporal Model Budget Constraints:

y1, y2 are exogenous incomes b1 are savings from period 1 to period

2 r is the interest rate

)1(122

111

rbyc

ybc

Consumer’s optimization Consumers maximize utility subject to

budget constraints

Lagrangean)1(

. )()(max

122

11121,, 121

rbyc

ybctscUcUbcc

))1((

) (

)()(max),,,,(

2122

1111

21,,

21121121

crby

bcy

cUcUbccLbcc

Consumer’s optimization First order conditions

Euler Equation

)1(

)(

)(

21

22

11

r

cU

cU

)()1()( 21 cUrcU

A) Consumer’s optimization Log utility:

Solution:

)1(1

2 rc

c

*11

*1

21

*1 1

1

cyb

ry

yc

Where are we?

A Basic Intertemporal Model A) Consumer Optimization B) Market Equilibrium C) Adding capital stock D) Welfare Theorems E) Infinite horizon

B) Market Equilibrium

Suppose that there is N identical agents Market clearing condition is

Log utility:

0)( **1 rNb

1

2*

21

1

1

11

y

yr

r

yy

y