Introduction

ECON 30020: Intermediate Macroeconomics

Prof. Eric Sims

University of Notre Dame

Spring 2018

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Readings

I GLS Chapters 1, 2, and 3

I GLS Appendix A

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Introduction

I Macroeconomics:
I Better called aggregate economics
I Focus on dynamic and intertemporal nature of economic
decision-making
I Economics is “micro”: “macro” just studies issues at
aggregated (country) level
I Key questions:
I Why does the economy grow over time?
I Why are some countries rich and others poor?
I Why do economies experience recessions?
I What is the role of government?
I More recently:
I What the heck happened in 2007-2009?

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Logistics

I Syllabus
I Textbook
I Assignments and grading
I Office hours
I TAs
I Course outline

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Gentle Reminder

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About Me

I Associate Professor, Dept. of Economics

I B.A. Trinity University, 2003
I “Miracle in Mississippi” October 27, 2007
I Ph.D. University of Michigan, 2009
I Don’t get the wrong picture
I Wife proud ND graduate – Lewis chicken
I Signed Charlie Weis picture in office (oops?)
I Michigan Sucks

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Out of Style

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In Style I

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In Style II

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My Effect on Notre Dame Football

Notre Dame Winning % By Decade

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ND WP
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Sims arrival

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0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

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Math

I “It is true that modern macroeconomics uses mathematics

and statistics to understand behavior in situations where there
is uncertainty about how the future will unfold from the past.
But a rule of thumb is that the more dynamic, uncertain and
ambiguous is the economic environment that you seek to
model, the more you are going to have to roll up your sleeves,
and learn and use some math. That’s life.” – Thomas
Sargent, 2011 Nobel Prize Winner

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What Kind of Math We Will Be Using

I Basically:
I Algebra
I Differential calculus
I Will also need to know:
I Microsoft Excel
I How to play with graphs
I Some basic statistics
I See GLS Appendixes A and B
I TA office hour sessions this week

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Variable Types and Timing Notation

I Two kinds of variables: exogenous and endogenous

I Exogenous: taken as given, determined outside of a model
I Endogenous: determined inside of a model
I Will denote variables with Latin letters
I Timing notation: time is discreet. t is the present. t − 1 is
one period in the past. t + 1 is one period in the future
I e.g. Xt is the value of variable X observed at date t
I Parameter: fixed value governing mathematical relationships
in a model
I Will typically denote parameters with lowercase Greek letters
(e.g. α, β), sometimes with lowercase Latin letters without a
time subscript

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Basic Accounting
I GDP: current dollar value of all final goods and services
produced within a country during a particular period of time
I GDP a measure of production and a flow concept
I Production = Income = Expenditure
I Income approach:

GDPt = Wagest + Interestt + Rentt + Profitt

I Expenditure approach:

GDPt = Consumptiont + Investmentt + Governmentt + Net Exportst

I See GLS Ch. 1.

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Real vs. Nominal I

I GDP is defined in terms of current dollar prices

I Effectively, prices are weights reflecting relative valuations of
different goods
I But makes comparisons across time difficult
I Want a “real” or “inflation-adjusted” measure of GDP
I How to do this?

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Real vs. Nominal II
I In a single good world (most of this course), something real is
denominated in quantities of goods, whereas nominal is
measured in units of money (i.e. dollars)
I So suppose you produce 10 cans of beer valued at $2 per can.
Real quantity is 10 cans, nominal value is $20
I Not so obvious how to do this with many different goods (the
real world, but not most of this course)
I Solution: “constant dollar” GDP. Value quantities of goods at
different points in time using fixed prices (base year prices).
So real GDP actually denominated in units of money, but
facilitates comparisons over time
I Can “back out” a measure of aggregate prices via the implicit
price index: ratio of nominal (current dollar) GDP to real
(constant dollar) GDP
I Inflation: rate of growth of price index
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Variable Notation
I Yt : real GDP (also output, income, production)
I Ct : consumption
I It : investment
I Gt : government spending
I NXt : net exports
I Pt : price level. Price level times real value of any of these is
the nominal value – e.g. Pt Yt is nominal GDP
I Nt : labor hours (also labor input)
I Kt : capital stock
I rt : real interest rate
I wt : real wage
I it : nominal interest rate
I Wt : nominal wage
I πt : inflation rate
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What Economists Do

I Basically three related modes of inquiry:

I Retrospective: trying to understand what happened in the past
and why it happened
I Counterfactuals: trying to understand what would have
happened under some alternative scenario or policy regime
I Policy advice: trying to advise policymakers on what to do in
the future
I Ultimately our objective is to give sound policy advice, but to
do so need to conquer retrospective and counterfactual
analysis

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Models
I For better or worse, the real world is messy
I It isn’t always easy to do retrospective analysis (e.g. why did
the Great Recession happen?), it’s hard to do counterfactual
analysis (e.g. what would have happened had the Fed not
done Quantitative Easing?), it’s even harder to give policy
advice about the future (e.g. should the Fed raise interest
rates?)
I Economics tries to be scientific. In an ideal world, we would
like to run experiments
I What happens when the Fed raises or lowers interest rates?
I Run an experiment: have a bunch of economies otherwise
subject to the same conditions. Change interest rates for one
group of economies (the treatment group) and don’t for the
other group (the control group). Compare differences across
groups to get the “treatment effect”
I For most macro questions, this kind of experiment is
impossible
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The Art and Science of Economic Models

I Because experiments aren’t in play, economists use models

I Given a model, we try do “real science”: run experiments, and
use the outcomes from those experiments to inform policy
I But building the model itself is as much art as it is science

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A Model

MODEL
Exogenous variables Decision rules coming from optimization Endogenous variables
subject to scarcity

Equilibrium / market-clearing conditions

Governed by mathematical relationships

and parameters

I A model makes predictions about endogenous variables

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How to Judge / Build a Model

I No firm criteria. This is the “art” part

I Characteristics of a good model:
I Makes good predictions
I Stronger test: makes good predictions about things which it
wasn’t designed to explain (“over-identification”)
I Is as simple as possible
I Abstract from things which are not relevant
I The simpler it is, the easier it is to understand the mechanisms
I Makes reasonable assumptions

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Models in This Course

I In macro, we do a lot of abstraction (e.g. we assume everyone

is the same!)
I Course divided into three “runs” which feature differing levels
of abstraction:
I Long run (decades): abstract from endogenous labor input and
many sources of shocks, focus on capital accumulation and
productivity growth. Solow model
I Medium run (several years): abstract from capital
accumulation and productivity growth, abstract from nominal
price and wage rigidity. Neoclassical model
I Short run (months to several years): abstract from capital
accumulation and productivity growth, allow for price and/or
wage stickiness. New Keynesian model
I In addition, close the course with a section on banking/finance
and the Great Recession, which builds off the short run part

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