Core Macroeconomics, Hilary Term 2015

Week 3: A Keynesian closed-economy model

This week's focus is the closed economy model that Carlin & Soskice present in Chapter 3, which is built up from three components: an IS-LM demand side; a supply side derived from the imperfectly competitive labour market model; and a monetary policy rule for the central bank. We will use the model to discuss the economy's response to various shocks, and the implementation of monetary policy. We will also look in a bit more detail at how monetary policy works.

We will not discuss in any detail, this week, the New Keynesian effort to build models featuring rational expectations and optimising decisions by households and firms ("microfoundations"), in which aggregate demand, more particularly money, nonetheless has a persistent impact on the economy. We may discuss this topic later in term.

Readings

The primary reading for this week is C&S Chapters 1-4 in either the new or old edition.

The following readings are relevant for the essay topics.

On central bank responses to inflation:

Ball, L. "What Determines the Sacrifce Ratio?" available in working paper version on line or published in Monetary Policy N.G. Mankiw, ed. (U. of Chicago Press, 1994).
Temple, J. "Openness, Inflation, and the Phillips Curve: A Puzzle," Journal of Money, Credit and Banking vol. 34, no. 2 (May 2002), pp. 450-68.
Caporale, B. and T. Caporale, "Political Regimes and the Cost of Disinflation" JMCB, vol. 40 no. 7 (Oct. 2008), pp. 1541-54.

On unemployment:

Nickell, S., L. Nunziata, and W. Ochel, "Unemployment in the OECD since the 1960s: What Do We Know?", Economic Journal, vol. 115, no. 1 (January 2005), pp. 1-27.

There are a number of useful, accessible articles in the Journal of Economic Perspectives. The Winter 1997 (vol. 11, no. 1) issue has a symposium on the natural rate of unemployment, with articles by a number of prominent scholars. "What we know and do not know about the natural rate of unemployment," by Olivier Blanchard and Lawrence Katz, has an exposition of the competing claims model. The Autumn issue of the same year has a symposium on European unemployment with articles by Nickell and Siebert. In the Winter 2001 (vol. 15, no. 1) issue, Lindbeck & Snower's article "Insiders versus Outsiders" is worth a read. Finally, Ball & Mankiw have a useful article on "The NAIRU in Theory and Practice" in vol. 16, no. 4 (Autumn 2002).

D. Romer's Advanced Macroeconomics, Ch. 9, offers an exposition of several models of equilibrium unemployment. This material is concise and good, but also a bit challenging and technical.

C&S chapter 15 (new ed), parts of 18 avoiding the international model (old ed).

Assignment

Please write an essay on one of the following topics. Even if you write on topic 1, please make an effort to incorporate evidence - which might be one or more case studies of particular episodes, or might be more systematic, quantitative data - in addition to an exposition of the theoretical issues.

1. What determines the degree to which the monetary authorities should respond to a rise in inflation above the target rate?

2. Use the "competing claims" model to explain observed variation in unemployment rates among OECD countries. You might start with the Nickell et al. reading (do your best to understand the regression and simulation results there, not worrying if some of the technical points elude you) but I hope you won't stop there.