INTERMEDIATE MACROECONOMICS (EC202)

Course duration: 54 hours lecture and class time (Over three weeks)

LSE teaching department: Department of Economics

Lead faculty: Dr Kevin Sheedy and Professor Ricardo Reis

Course objective: This course aims to bring you up to date with modern developments in
macroeconomic theory and offer fresh perspectives on the macroeconomic challenges of the
day. The course is essentially structured around a series of key questions:

What are the forces that drive long-term prosperity?

What are the features of labour markets that make them special, and why does unemployment
occur?
How should households and firms make plans for the future?
What are the consequences of high levels of government debt?
What are central banks and how do they control interest rates?
What are the functions of financial markets, and why are financial crises so violent?
Why does economic activity fluctuate and what does austerity have to do with recessions?
Can fiscal and monetary policy fine-tune the economy?

The approach of the course is to discuss the salient features of the data and then go on to 1
present macroeconomic models to study these issues.

Prerequisites: Introductory macroeconomics and microeconomics, multivariate calculus (in particular,

constrained optimisation).

Content: The course covers the following topics: macroeconomic measurement and data, the labour
market, economic growth, consumption and saving, investment, unemployment, a dynamic
macroeconomic model, money and interest rates, financial markets, business cycles and
stabilisation policy, and the limits of fiscal and monetary policy.

Textbook: For the first part of the course, chapters from S Williamson, Macroeconomics, 5th ed., Pearson
and D Weil, Economic Growth, 2nd ed., Prentice Hall. For the second part of the course, O
Blanchard and D R Johnson, Macroeconomics, 6th ed., Pearson. These readings are available in a
combined package from the Economists Bookshop.

Lectures: 36 hours Classes: 18 hours

Formative assessment: One marked homework exercise

Summative assessment: Two written examinations

Course content is subject to change Last updated: July 2017

 Outline and Readings: Part I

Macroeconomic measurement and data

- Measuring GDP and discussion of factors that are left out by GDP measures
- Comparing real GDP over time and across countries

Reading: Blanchard and Johnson, chapter 2.

The labour market

- The labour supply decision of a utility-maximizing household

- The labour demand decision of a profit-maximizing firm
- Competitive equilibrium and Pareto optimality

Reading: Williamson, chapters 4-5.

Economic growth

- Key growth facts 2

- A Malthusian model of stagnation in output per capita prior to the 19th century
- The Solow model of growth in output per capita since the industrial revolution
- Growth accounting and development accounting
- Three classes of endogenous growth models: learning-by-doing, human capital accumulation,
research and development

Reading: Williamson, chapters 7-8; Weil, chapters 7-9.

Consumption and saving

Consumption and saving behaviour of a forward-looking utility-maximizing household

Ricardian equivalence and the role of government
Social security programmes: pay-as-you-go and fully funded programmes
Credit market imperfections: asymmetric information, limited commitment, and the financial
crisis

Required reading: Williamson, chapters 9-10.

Course content is subject to change Last updated: July 2017

Investment

Investment behaviour of a forward-looking profit-maximizing firm

Tobins q theory of investment and the link between investment and the stock market

Required reading: Williamson, chapter 11.

Unemployment

Key labour market facts

Sticky wages as an explanation for unemployment: efficiency wage model
Stocks and flows in the labour market
A simple search model of unemployment focusing on workers search for jobs
Equilibrium search model of unemployment: workers search for vacancies and firms post
vacancies to search for workers

Required reading: Williamson (4th ed.), chapter 17; Pissarides, chapter 1.

A dynamic macroeconomic model

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A general-equilibrium macroeconomic model of the goods, labour, and bond markets
Analysis using the dynamic model: The effects of shocks and news about the future

Required reading: Williamson, chapter 11.

Course content is subject to change Last updated: July 2017

 Outline and Readings: Part II

Topic 1: Money and interest

Question: What are the functions of money and how is the price level determined?

Application: The economics of a POW camp and how to avoid an hyperinflation.

Concepts and tools: double coincidence of wants, quantity theory, seignorage,

monetarism, expectations.

Readings:
* Blanchard and Johnson, chapter 4.
- Radford, R. (1945). The Economic Organisation of a P.O.W. Camp. Economica,
12(48), 189-201.

Question: What is a central bank, and how are interest rates determined?

Application: Are central banks powerless if people no longer hold cash? What is forward
guidance?

Concepts and tools: reserves, quantitative easing, corridor system, arbitrage, Fisher
equation, Taylor rule, term structure, yield curve.

Readings:
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* Blanchard and Johnson, chapters 14-15.
- Reis, Ricardo (2013). Central Bank Design. Journal of Economic Perspectives, 27(4),
17-44.

Topic 2: Financial markets

Question: What are the functions of banks and what is the role of the financial system?

Application: What happened in 2007-08, and were economists shaken by it?

Concepts and tools: Diamond-Dybvig model, maturity transformation, bank runs, off-
equilibrium threats, moral hazard.

Readings:
* Diamond Douglas W. (2007). Banks and liquidity creation: a simple exposition of the
Diamond-Dybvig model." FRB Richmond Economic Quarterly 93 (2), 189200.
- Brunnermeier, Markus (2009). Deciphering the Liquidity and Credit Crunch
2007-2008. Journal of Economic Perspectives, 23(1), 77-100.

Question: What determines the exchange rate?

Application: The euro project.

Concepts and tools: twin deficits, PPP, currency crashes, UIP, trilemma, pegs and floats,
currency unions, speculative attacks.

Course content is subject to change Last updated: July 2017

Readings:
* Blanchard and Johnson, chapters 18-21.
- Taylor, Alan M. and Mark P. Taylor (2004). "The Purchasing Power Parity Debate."
Journal of Economic Perspectives, 18(4), 135-158.

Question: Why are financial crises so violent?

Application: What happened to GIPS in the last 5 years?

Concepts and tools: default risk, modern banks, misallocation, amplification, multiplicity,
debt, diabolic loop.

Readings:
* Brunnermeier, Markus and Ricardo Reis (2016). A Crash Course on the Euro Crisis
- Blanchard and Johnson, chapter 9.

Topic 3: business cycles and stabilization policy

Question: Should we have deficits or loose money during recessions?

Application: The austerity debates.

Concepts and tools: IS-LM model, aggregate demand, crowding out, multipliers,
fiscalists, monetarists, automatic stabilizers.
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Readings:
* Blanchard and Johnson, chapters 3-5.
- Romer, Christina and David Romer (2002). The Evolution of Economic Understanding
and Postwar Stabilization Policy. In Rethinking Stabilization Policy, Jackson Hole
Economic Policy Symposium: Federal Reserve Bank of Kansas City.

Question: Why isnt economics like engineering?

Application: The stagflation of the 1970s.

Concepts and tools: Aggregate supply, nominal rigidities, Phillips curve, sacrifice ratio, rational
expectations, Lucas critique.

Readings:
* Blanchard and Johnson, chapters 7-8.
- Mankiw, N. Gregory (2006). The Macroeconomist as Scientist and Engineer. Journal
of Economic Perspectives, 20(4): 2946.

Topic 4: the limits of fiscal and monetary policy

Question: Why isnt discretion better than rules? How to design institutions?

Application: Raising a teenage child.

Course content is subject to change Last updated: July 2017

Concepts and tools: Time inconsistency, Barro-Gordon model, inflation bias, central
bank independence, contracts, inflation targeting.

Redings:
* Blanchard and Johnson, chapter 22.
- Barro, Robert and David Gordon (1983). A Positive Theory of Monetary Policy in a
Natural Rate Model. Journal of Political Economy, 91(4), 589-610.

Question: How to finance a war, and how to prevent temptations?

Application: Obesity and the Greek crisis.

Concepts and tools: Tax smoothing, debt management, social transfers, dynamic
inconsistency, hyperbolic discounting, self commitment, debt sustainability.

Readings:
* Blanchard and Johnson, chapter 23.
- Akerlof, George A. (1991). Procrastination and Obedience. American Economic Review, 81(2),
1-19.

Course content is subject to change Last updated: July 2017