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Research in Economics

Son T. Pham
August 26, 2024

Key Terms in Research: What is


Research?
 Misconceptions: 1) fact transferal; 2) laboratory research
 Webster's Collegiate Dictionary (1996) defines research as "studious
inquiry or examination; esp: investigation or experimentation aimed at
the discovery and interpretation of facts, revision of accepted theories
or laws in the light of new facts, or practical application of such new
or revised theories or laws".

Other definitions
 Research Methods and Research Methodology
 Types of Research
 Descriptive vs. Analytical Research
 Disciplinary, Subject-Matter, and Problem-Solving Research

What is economics and what do


economists do?
(1) What is economics?

 A theory
 The Data
(2) What do economists do?
 Observing Facts and Trends in Data
 Explaining and Predicting/Forecasting the Relationship
(3) Explaining and Predicting the Relationship: fact and raising
analytical questions regarding facts

Scientific Method
 Non-Scientific Method: Senses and Experiences, intuition and
revelation
 Scientific Method: learning by reasoning, subjected to testing
 Deductive and Inductive Logic or logical process
 Hypothesis, Theory, and Law
 Two Types of Relationship: Correlation and Causation
 Modeling Causal Relationship: macroeconomic stabilization policy and
short-run macroeconomic fluctuations
 Assumptions about policymakers' behavior and their economic
environment affecting decision making
 Hypothesis: appropriate stabilization policy and macroeconomic
management result in smaller and less frequent macroeconomic
fluctuations
 Model and testing

Describing Business cycles


(1) The depth and duration of both individual and average economic
contractions and expansions.
(2) How different macroeconomic variables move in relation to each other
during contractions and expansions?
3 Examining the macroeconomic data.

Trend-Cycle Decomposition
To characterize business cycle facts we decompose a time series, y t , into a

 cyclical component, y ct , and a


 secular (or trend) component, y st ,c s
yt = yt + yt
(1)
There are various methods to extract the cyclical component. Here is a list
of commonly used ones:

 log-linear detrending
 log-quadratic detrending
 HP filtering
 Time differences
 Band pass filtering

Log-linear detrending
Let
y t ≡ ln ⁡Y t
(2)
denote the natural logarithm of a time series Y t , such as real GDP per capita,
where t denotes time. Then write
y t =a+ b t+ϵ t
(3)
where
cycle: y ct =ϵ t
secular trend: y st =a+b t
The parameters a and b can be estimated via ordinary least squares (OLS).
2
y t=a+b t +c t +ϵ t
Log-quadratic detrending c
(4)
cycle: y t =ϵ t
(5)
Again, the parameters a , b ,secular
and c trend:
can be y st estimated
=a+b t +c t 2via OLS.
(6)
Vietnam BC - Vietnam real GDP per
capita detrending

US BC - US real GDP per capita


detrending
Quadratic best fitted trend Comperaing cyclical components

BC facts with annual data


 Data Source: Annual data from the World Development Indicators
(WDI), starting in 1960 and ending in 2022 or 2023.
 Restriction: To be included in the present sample, a country must
have at least 30 consecutive observations of the following six
variables:
 y t ¿ of ¿ real GDP per capita
 c t (log of) real private consumption per capita
 gt ( log of) real government consumption per capita
 i t ( log of) real investment per capita
 x t ¿ of ¿ real exports per capita
 mt (log of) real imports per capita
 A variable is said to be procyclical, countercyclcal, or acyclical if its
correlation with output is, respectively, positive, negative, or close to
zero.
 Other important indicators: the aggregate price level, short-, long-
term interest rates and Monetary aggregates
A Comment on the Consumption
Data
 The WDI private consumption series includes expenditures on
nondurables, services, and durables.
 Unfortunately, most countries do not publish disaggregated
consumption data.

Modelling BC
Macroeconomic Theories of Business Cycles: Four main BC theories:

 Keynesian economics, i.e., the principal of effective demand, hence


governments' role to stabilize the economy
 Monetarism, self-correcting forces of the economy work sufficiently
fast such that there is no need for demand management,
macroeconomic stabilizing policies more likely to add more
fluctuations
 New Classical Economics (long-run), emphasizes rigorous foundations
based on microeconomics, rational expectations theory, and
equilibrium
 New Keynesian (NK) Economics (short-run), nominal rigidities

New Keynesian (NK) Models


What is a model ?

 "A theoretical (hypothetical) construct that represents a process by a


number of variables and a set of quantitative, or logical, relationships
between them." (By Jennifer Ann Francis (Physicist))
 "A simplistic theoretical and/or empirical method explaining
complicated processes." (By Peter James Richerson (Physicist))
 "The best way to simply (wrongly) describe some workings of the
economy." An Economist
The basic structure of a DSGE model

Compact form of a NK model


 Let y be a n ×1 vector of endogenous variables, u is a q × 1 vector of
innovations (will come back to these innovations later!)
 We consider the following type of model:
Et [ f ( y t +1 , y t , y t −1 ,u t ) ] =0
(7)
With
ut =σ ϵ t
(8)
E t [ ϵ t ]=0
(9)
where σ is a scale parameter, ϵ isEat [ vector
ϵ t ϵ t ]=Σof
ϵ auxiliary random (shocks).
variables (10)
 Assumption f : R 3 n+q → R n is a differentiable function in C k .
 A deterministic (trend) steady state, y ∗, for the model satisfies
Et [ f ( y , y , y , 0 ) ]=0
∗ ∗ ∗

(11)

Overview: What Is a Shock?


 Widely accepted definition: The shocks should be primitive exogenous
forces that are uncorrelated with each other and they should be
economically meaningful. For instance, shocks to technology,
monetary policy, and fiscal policy, labour shifting etc.
(1) should be exogenous with respect to the other current and lagged
endogenous variables in the model;
2 should be uncorrelated with other exogenous shocks;
(3) should represent either unanticipated movements in exogenous
variables or news about future movements in exogenous variables.
 would fiscal and monetary policies be correlated?
 to identify and estimate these structural shocks we need models (VAR
or NK).

Monetary Policy
 Objectives of monetary policy (problem of short-term trade-off
between the stabilization of inflation and the stabilization of the
welfare-relevant output gap)
 stable prices, i.e., FED and ECB targeting inflation rate growing at
less than or close to 2 % (in Vietnam, the inflation target is around 4 %,
annually) why?
 full employment, depending on the type of shocks (aggregate demand
or permanent supply shocks → no trade-off) hitting the economy in
the concept of divide coincidence and non-trivial assumption on the
absence of real wage rigidity.
 and steady growth, equitable distribution of income, balance of
payments equilibrium (medium term)
 instrumental tools
 interest rates
 money supply
 unconventional tools
Thanks for your attention, Questions?

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