Advanced Macroeconomics I

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1 Advanced Macroeconomics I Professors: Luisa Fuster and Felix Wellschmied UC3M September 1, 2015 Dates. Monday and Thursday 15:00 to 17:15. Final Exam: TBA. Objective. The objective of the course is to introduce the modeling of heterogeneous agents economies, learn about economies with incomplete markets and uninsurable risk. In the first part of the course, the student will familiarize with the modern quantitative techniques used in macroeconomics, and will be exposed to important research questions in macroeconomics. In addition, the course will review some of the numerical methods used to solve heterogeneous agents economies with incomplete markets. A cornerstone to the theory of incomplete markets is uninsurable (income) risk which households face. In the second part of the course, students will familiarize with recent approaches that infer the size and structure of this risk from micro-data. The course covers both reduced form and structural approaches. Requirements. The course requires some basic knowledge of: (1) dynamic programming, (2) measure theory, and (3) Markov chains. There are several references to refresh the basics of dynamic programming: a simple one is Chapter 3 in Ljungqvist and Sargent (2004) but the most complete source is Stokey, Lucas, and Prescott (1989). Its first chapter is a very easy help. For measure theory you can check Stokey, Lucas, and Prescott (1989, chapter 7) For Markov chains, a good reference is Ljungqvist and Sargent (2004, chapter 2). A very comprehensive treatment can be found in Stokey, Lucas, and Prescott (1989, chapter 8). For the second part of the course, students are expected to have basic knowledge of search theory. This includes dynamic programming in continuous time. Ljungqvist and Sargent (2004), Chapters and provide a nice introduction with discrete time. Pissarides (2000), Mortensen and Pissarides (1999a), and Mortensen and Pissarides (1999b) provide additional insights. Rogerson, Shimer, and Wright (2005) is an extensive survey of search frameworks which go beyond the framework we cover in this course. Additionally, they provide a nice comparison between discrete and continuous time within a simple framework. Students should also have basic knowledge in econometrics about time series models and general method of moments estimation (GMM).

2 Homework. Some of the homework will be computer based. It is recommended you do the computer-based problem sets in pairs. Please, submit just one copy per group. Grading. The final grade on the course will be based on: 1. Homework assignments (40%). 2. A final exam (60%). Part I. The neoclassical growth model with heterogeneous agents. 1. Introduction 2. Theoretical Framework The neoclassical stochastic growth model: recursive formulation. Brock and Mirman (1972) and Stokey, Lucas, and Prescott (1989, chapter 1). Stylized facts on inequality. Budría, Díaz-Giménez, Quadrini, and Ríos-Rull (2002), Krueger, Perri, Pistaferri, and Violante (2010) and Heathcote, Perri, and Violante (2010a). The heterogeneous agents model in steady state. Huggett (1993) and Aiyagari (1994). For a textbook exposition see Ljungqvist and Sargent (2004, chapters 16 and 17). 3. Data The importance of uninsurable idiosyncratic shocks and precautionary savings. Storesletten, Telmer, and Yaron (2004a) and Kaplan and Violante (2009). Accounting for the wealth distribution. Castañeda, Díaz-Giménez, and Ríos-Rull (2003) and Cagetti and Nardi (2006). Part II. Numerical methods applied to heterogeneous agents economies. 1. Introduction: basic concepts on numerical solutions. 2. Solving the household problem Value function iteration: discretization. Policy function iteration. Endogenous grid method. Hintermaier and Koeniger (2010) 2

3 3. Finding the steady state equilibrium. Aiyagari (1994) and Ríos-Rull (1998) 4. Accuracy. Judd (1992) Part III. Precautionary Savings Motive and Social Security Reform. 1. Precautionary savings motive: Fuchs-Schundeln (2008) 2. Quantifying Social Security Distributional and Welfare Effects: Imrohoroglu, Imrohoroglu, and Joines (1995), Fuster (1999), Fuster, Imrohoroglu, and Imrohoroglu (2007),? 3. Health Risk and Savings: De Nardi, French, and Jones (2002) Part IV. Stylized Facts About Income Risk Over the Life-Cycle. 1. Earnings and income risk in the US: (Heathcote, Perri, and Violante 2010b) 2. GMM estimation of income risk: (Tonetti 2011) 3. Earnings risk within and between jobs: (Topel and Ward 1992) Part V. Globalization as Source of Income Risk. 1. Import competition and income risk: (Krishna and Senses 2014) 2. Earnings and employment effects of import competition: (Autor, Dorn, Hanson, and Song 2014) Part VI. Wage Risk, Wage Inequality, and Search Frictions. 1. Search Frictions and Wage Inequality: (Hornstein, Krusell, and Violante 2012) 2. Search frictions with on-the-job search: (Tjaden and Wellschmied 2014) 3. Estimating wage risk and employment risk: (Low, Meghir, and Pistaferri 2010) Part VII. Consumption Insurance Against Risk. 3

4 1. Consumption responses to permanent and transitory shocks: (Blundell, Pistaferri, and Preston 2008) 2. Shock persistency, borrowing constraints, and consumption insurance: (Kaplan and Violante 2010) 3. Limited commitment as source of consumption risk: (Krueger and Perri 2006) 4. Sources of consumption insurance: (Blundell, Graber, and Mogstad 2014) 5. Insurance within the firm: (Guiso, Pistaferri, and Schivardi 2005) Part VIII. Structure of Income Risk. 1. Heterogeneous income profiles: (Guvenen 2007) 2. Reduced income profiles: (Hryshko 2012) 3. Countercyclical income risk: (Storesletten, Telmer, and Yaron 2004b) 4. Skewness of income risk over the cycle: (Guvenen, Ozkan, and Song 2014) 4

5 References Aiyagari, S. R. (1994): Uninsured Idiosyncratic Risk, and Aggregate Saving, Quarterly Journal of Economics, 109(3), Autor, D. H., D. Dorn, G. H. Hanson, and J. Song (2014): Trade Adjustment: Worker Level Evidence, Quarterly Journal of Economics, 129(4), Blundell, R., M. Graber, and M. Mogstad (2014): Labor Income Dynamics and the Insurance from Taxes, Transfers, and the Family, Discussion paper, University College London. Blundell, R., L. Pistaferri, and I. Preston (2008): Consumption Inequality and Partial Insurance, American Economic Review, 98(5), Brock, W., and L. Mirman (1972): Optmal Economic Growth and Uncertainty: the Discounted Case, Journal of Economic Theory, 3(4), Budría, S., J. Díaz-Giménez, V. Quadrini, and J.-V. Ríos-Rull (2002): New Facts on the U.S. Distribution of Earnings, Income and Wealth, Federal Reserve Bank of Minneapolis Quarterly Review, 26(3), Cagetti, M., and M. D. Nardi (2006): Entrepreneurship, Frictions, and Wealth, Journal of Political Economy, 114(5), Castañeda, A., J. Díaz-Giménez, and J.-V. Ríos-Rull (2003): Accounting for U.S. Earnigns and Wealth Inequaltiy, Journal of Political Economy, 111(4), De Nardi, M., E. French, and J. B. Jones (2002): Why Do the Elderly Save? The Role of Medical Expenses, Journal of Political Economy, 118(1), Fuchs-Schundeln, N. (2008): The Response of Household Saving to the Large Shock of German Reunification, American Economic Review, 98(5), Fuster, L. (1999): Is Altruism Important for Understanding the Long-run Effects of Social Security, Review of Economic Dynamics, 2(3), Fuster, L., A. Imrohoroglu, and S. Imrohoroglu (2007): Elimination of Social Security in a Dynastic Framework, Review of Economic Studies, 74(1), Guiso, L., L. Pistaferri, and F. Schivardi (2005): Insurance within the Firm, Journal of Political Economy, 113(5), Guvenen, F. (2007): Learning Your Earning: Are Labor Income Shocks Really Very Persistent?, American Economic Review, 97(3),

6 Guvenen, F., S. Ozkan, and J. Song (2014): The Nature of Countercyclical Income Risk, Journal of Political Economy, 122(3), Heathcote, J., F. Perri, and G. Violante (2010a): Unequal We Stand: An Empirical Analysis of Economic Inequality in the United States, , Review of Economic Dynamics, 1(13), Heathcote, J., F. Perri, and G. L. Violante (2010b): Unequal we stand: An Empirical Analysis of Economic Inequality in the United States, , Review of Economic Dynamics, 13, Hintermaier, T., and W. Koeniger (2010): The Method of Endogenous Gridpoints with Occasionally Binding Constraints among Endogenous Variables, Journal of Economic Dynamics and Control, 34, Hornstein, A., P. Krusell, and G. L. Violante (2012): Frictional Wage Dispersion in Search Models: A Quantitative Assessment, American Economic Review, 101(7), Hryshko, D. (2012): Labor Income Profiles are not Heterogeneous: Evidence from Income Growth Rates, Quantitative Economics, 3(2), Huggett, M. (1993): The Risk Free Rate in Heterogeneous-Agents, Incomplete Insurance Economies, Journal of Economic Dynamics and Control, 17(5/6), Imrohoroglu, A., S. Imrohoroglu, and D. Joines (1995): A Life-Cycle Analysis of Social Security, Economic Theory, 6(1), Judd, K. L. (1992): Projection Methods for Solving Aggregate Growth Models, Journal of Economic Theory, 58, 410:452. Kaplan, G., and G. Violante (2009): How Much Consumption Insurance Beyond Self- Insurance?, Mimeo, New York University. Kaplan, G., and G. L. Violante (2010): How Much Consumption Insurance beyond Self- Insurance?, American Economic Journal: Macroeconomics, 2(4), Krishna, P., and M. Z. Senses (2014): International Trade and Labour Income Risk in the U.S., Review of Economic Studies, 81(1), Krueger, D., and F. Perri (2006): Does Income Inequality Lead to Consumption Inequality? Evidence and Theory, Review of Economic Studies, 73(2), Krueger, D., F. Perri, L. Pistaferri, and G. Violante (2010): Cross Sectional Facts for Macroeconomists, Review of Economic Dynamics, 13(1), Ljungqvist, L., and T. Sargent (2004): Recursive Macroeconomic Theory. The MIT Press, Cambridge, Massachusetts, Second Edition. 6

7 Low, H., C. Meghir, and L. Pistaferri (2010): Wage Risk and Employment Risk over the Life Cycle, American Economic Review, 100(4), Ríos-Rull, J.-V. (1998): Computing Equilibria in Models with Heterogenous Agents, in Computational Methods for the Study of Dynamic Economics, ed. by R. Marimon, and A. Scott, chap. 9. Oxford University Press. Stokey, N. L., R. E. Lucas, and E. C. Prescott (1989): Recursive Methods in Economic Dynamics. Harvard University Press. Storesletten, K., C. Telmer, and A. Yaron (2004a): Consumption and Risk Sharing over the Life Cycle, Journal of Monetary Economics, 51(3), Storesletten, K., C. I. Telmer, and A. Yaron (2004b): Cyclical Dynamics in Idiosyncratic Labor Market Risk, Journal of Political Economy, 112(3), Tjaden, V., and F. Wellschmied (2014): Quantifying the Contribution of Search to Wage Inequality, American Economic Journal: Macroeconomics, 6(1), Tonetti, C. (2011): Notes on Estimating Earnings Processes, Discussion paper, New York University. Topel, R. H., and M. P. Ward (1992): Job Mobility and the Careers of Young Men, The Quarterly Journal of Economics, 107(2),

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