How many ways are there to walk from A to B on the grid to the right, without backtracking? Recursive Macroeconomic Theory, 3rd Edition, MIT Press. One of the key techniques in modern quantitative macroeconomics is dynamic programming. In 1976, Robert Lucas, Jr., published an influential paper arguing that the failure of the Phillips curve in the 1970s was just one example of a general problem with empirical forecasting models. Dynamic Stochastic General Equilibrium (DSGE) models • DSGE models have become the fundamental tool in current macroeconomic analysis • They are in common use in academia and in central banks. 28, p. 540. DSGE models may exaggerate individual rationality and foresight, and understate the importance of heterogeneity, since the rational expectations, representative agent case remains the simplest and thus the most common type of DSGE model to solve. Recap: Dynamic problems are all about backward induction, as we usually do not have enough computing power to tackle the problem using an exhaustive search algorithm.1 [26] Like the DSGE methodology, ACE seeks to break down aggregate macroeconomic relationships into microeconomic decisions of individual agents. cit., Ch. Economics 200E: Introduction to Dynamic Macroeconomic Analysis Course Description: This course is designed as an introduction to dynamic macroeconomic analysis, particularly recursive methods. dynamic macroeconomic models with strategically interacting agents and limited commitment begun (and has continued for the last four decades). model will –rst be presented in discrete time to discuss discrete-time dynamic programming techniques; both theoretical as well as computational in nature. They claimed that the historical relation between inflation and unemployment was due to the fact that past inflationary episodes had been largely unexpected. King, Ian (2002). ÏçÒ©½:§¥síÜz»0µ}åìCÊÝÇâX°ÃË'`<¦#Pˆ°—zˆ;Š,WF._6DiXj±»c ¸È*æbÕìüMSS¼_¸q`³YÙ1okæ'¸ìwZ#^¯'Þ´;#äö?TC¡G– }žx¼¡°€ñûÇ\–ÑÓ6òÝ£+瘻_òVo÷̳÷vúŠnF¸¹Q)_˜ÐŠñÙÑüz ÒnÜS£:XÛpÒMD`3g|‘îم9Úf«µfô ª@ø¢ÆO6:¤°ŒO¶u€ñ…Áúû¬?Ýï-•O$ä4ѽÔ#ÿ­Ò>Q㢠À¬„Lø¥ The design of a System Dynamics model begins … These models argue that random shocks--new inventions, droughts, and wars, in the case of pure RBC models, and monetary and fiscal policy and international investor risk aversion, in more open interpretations--can trigger booms and recessions and can ac McCandless, George (2008). Summing up the decisions of the different types of agents, it is possible to find the prices that equate supply with demand in every market. This model is based on multiplier-accelerator model, and inventory – adjustment model. 2. By applying the principle of the dynamic programming the first order condi- tions for this problem are given by the HJB equation ρV(x) = max. Exercises — Introduction to Dynamic Programming Quick Concepts 1. [12][13] He pointed out that such models are derived from observed relationships between various macroeconomic quantities over time, and that these relations differ depending on what macroeconomic policy regime is in place. Also, unlike ACE models, it may be difficult to study local interactions between individual agents in DSGE models, which instead focus mostly on the way agents interact through aggregate prices. • Useful to analyze how economic agents respond to changes in their environment, in a dynamic general --Jesus Fernandez-Villaverde, University of Pennsylvania "Julia is a computer language that is taking economics by storm. [4], Dutch economist Jan Tinbergen developed the first comprehensive national model, which he built for the Netherlands in 1936. ≡K˙ (t)=I(t) −‰K(t). %[A+{oW3?Ô-*XßmŸ°;‡ÃM -åÐÒXšawl 1ÜìöcVKFrÙ4~ÔaG†qû(ㄈQ€–3áääÔ#«è^ü2kÕ^@¼¹yaAOmxÄ ÆUi¼. The main reference will be Stokey et al., chapters 2-4. ACE models also begin by defining the set of agents that make up the economy, and specify the types of interactions individual agents can have with each other or with the market as a whole. cit., Ch. [24][25] DSGE models instead emphasize the dynamics of the economy over time (often at a quarterly frequency), making them suited for studying business cycles and the cyclical effects of monetary and fiscal policy. f(u(t),x(t))e−ρtdt where ρ > 0, subject to the instantaneous budget constraint and the initial state dx dt ≡ x˙(t) = g(x(t),u(t)), t ≥ 0 x(0) = x0given hold. These models are usually designed to examine the comparative statics and dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the level of prices. Notes on Macroeconomic Theory Steve Williamson Dept. Suggested Citation. They are simple enough to be used as illustrations of theoretical points in introductory explanations of macroeconomic ideas; but therefore quantitative application to forecasting, testing, or policy evaluation is usually impossible without substantially augmenting the structure of the model. Blanchard, Olivier (2017), “The need for different classes of macroeconomic models”, blog post, Jan. 12, 2017, Peterson Institute for International Economics. Chapter 1 Simple Representative Agent Models This chapter deals with the simplest kind of macroeconomic model, which abstracts from all issues of heterogeneity and distribution among As such, the course will consist of a fairly thorough presentation of the ideas and techniques contained in the articles listed below. This model was set up to study a closed economy, and we will assume that there is a constant population. [1] Macroeconomic models may be used to clarify and illustrate basic theoretical principles; they may be used to test, compare, and quantify different macroeconomic theories; they may be used to produce "what if" scenarios (usually to predict the effects of changes in monetary, fiscal, or other macroeconomic policies); and they may be used to generate economic forecasts. Blanchard, Olivier (2000), op. dK(t) dt. A Simple Introduction to Dynamic Programming in Macroeconomic Models Author. "A concise and elegant introduction to many of the topics involved in the solution of dynamic macroeconomic models. However, in 1968, Milton Friedman[9] and Edmund Phelps[10] argued that this apparent tradeoff was illusory. He later applied the same modeling structure to the economies of the United States and the United Kingdom. Chapters 3, 4 and 5. George W. Evans and Seppo Honkapohja (2001), Wharton Econometric Forecasting Associates, "Econometric Policy Evaluation: A Critique", "An optimization-based econometric framework for the evaluation of monetary policy", "A general equilibrium calculation of the effects of differential taxation of income from capital in the US", "A primer on static applied general equilibrium models", Organisation for Economic Co-operation and Development, https://en.wikipedia.org/w/index.php?title=Macroeconomic_model&oldid=990833893, Creative Commons Attribution-ShareAlike License, This page was last edited on 26 November 2020, at 19:31. Dynamic stochastic general equilibrium (DSGE) is a macroeconomic model that facilitates macroeconomic analysis and policy making in central banks, as well as government and nongovernmental organizations (NGOs). Same question on the grid below. The ABCs of RBCs is the first book to provide a basic introduction to Real Business Cycle (RBC) and New-Keynesian models. 28, p. 542. Don't show me this again. [14] Furthermore, this means one cannot predict the effects of a new policy regime using an empirical forecasting model based on data from previous periods when that policy regime was not in place. [2] Many of these models are static, but some are dynamic, describing the economy over many time periods. A macroeconomic model is an analytical tool designed to describe the operation of the problems of economy of a country or a region. Large-scale empirical models of this type, including the Wharton model, are still in use today, especially for forecasting purposes. [22][23] More elaborate DSGE models are used to predict the effects of changes in economic policy and evaluate their impact on social welfare. Simple textbook descriptions of the macroeconomy involving a small number of equations or diagrams are often called ‘models’. Most modern dynamic models of macroeconomics build on the framework described in Solow’s (1956) paper.1 To motivate what is to follow, we start with a brief description of the Solow model. Another modeling methodology that has developed at the same time as DSGE models is Agent-based computational economics (ACE), which is a variety of Agent-based modeling. The course focuses on a mixture of methodological tools and economic substance relevant to empirical macroeconomics. Dynamic Programming 3. Models like the DSGE include frameworks that seek to predict the effects of changes in economic policy, while the ACE models aim to understand macroeconomic relations by going somewhat in detail on a microeconomic level. Thus these models embody a type of equilibrium self-consistency: agents choose optimally given the prices, while prices must be consistent with agents’ supplies and demands. Dynamic Programming I: Theory I LS, Chapter 3 (Extended with King (2002) “A Simple Introduction to Dynamic Programming in Macroeconomic Models”) Julen Esteban-Pretel National Graduate Institute for Policy Studies. Macroeconomic models may be logical, mathematical, and/or computational; the different types of macroeconomic models serve different purposes and have different advantages and disadvantages. Thus, macroeconomic models are widely used in academia in teaching and research, and are also widely used by international organizations, national governments and larger corporations, as well as by economic consultants and think tanks. They are based on a few equations involving a few variables, which can often be explained with simple diagrams. The Lucas critique of empirical forecasting models, Dynamic stochastic general equilibrium models, Agent-based computational macroeconomic models, Strengths and weaknesses of DSGE and ACE models. Either formulated as a social planner’s problem or formulated as an equilibrium problem, with each agent maximiz- In subsequent work, Kydland and Prescott (1980) proposed a new set of recursive methods for constructing time-consistent optimal policies in decentralized dynamic equilibrium models with capital and labor. "A Simple Introduction to Dynamic Programming in Macroeconomic Models," Working Papers 190, Department of Economics, The University of Auckland. Dynamic programming Martin Ellison 1Motivation Dynamic programming is one of the most fundamental building blocks of modern macroeconomics. Ian King (Auckland), A Simple Introduction to Dynamic Programming in Macroeconomic Models Paul Klein (Western Ontario), Solving the Growth Model by Linearizing the Euler Equations Dirk Krüger (Frankfurt), Macroeconomic Theory Dirk Krüger (Frankfurt), Quantitative Macroeconomics: An Introduction Lucas argued that economists would remain unable to predict the effects of new policies unless they built models based on economic fundamentals (like preferences, technology, and budget constraints) that should be unaffected by policy changes. The book is really simple to follow and also is a perfect guide for the homeworks I faced in my research program in matlab. John Maynard Keynes. Each agent is assumed to make an optimal choice, taking into account prices and the strategies of other agents, both in the current period and in the future. Many students have difficulty understanding the concept of dynamic programming, a problem solving approach appropriate to use when a problem can be broken down into overlapping sub-problems. These models are usually designed to examine the comparative statics and dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the level of prices. Like the simpler theoretical models, these empirical models described relations between aggregate quantities, but many addressed a much finer level of detail (for example, studying the relations between output, employment, investment, and other variables in many different industries). of Economics Washington University in St. Louis St. Louis, MO 63130 September 2006. "The ABCs of RBCs is the first book to provide a basic introduction to Real Business Cycle (RBC) and New Keynesian models. It assumes that readers have no further mathematical background than an undergraduate "Mathematics for Economists" course. Caraiani 's use of Julia is a fantastic choice for teaching modern numerical methods." A related issue is that ACE models which start from strategies instead of preferences may remain vulnerable to the Lucas critique: a changed policy regime should generally give rise to changed strategies. This expression is a particular case of more general dynamic constraints encountered in economic applications. It is applicable to problems exhibiting the properties of overlapping subproblems which are only slightly smaller and optimal substructure (described below). Advanced Macroeconomics: Estimation and Analysis of Dynamic Macroeconomic Models. They argued that if monetary authorities permanently raised the inflation rate, workers and firms would eventually come to understand this, at which point the economy would return to its previous, higher level of unemployment, but now with higher inflation too. The level and rate of change ofy(t), a stock variable, are linked to one or more flow variableszand to exogenous variables by anaccumulation constraintin the form of. 91(1), pages 39-69, February. Define subproblems 2. It assumes that readers have no further Or sometimes, preferences are specified, together with an initial strategy and a learning rule whereby the strategy is adjusted according to its past success. The course is the first in the three-part 416 series. [8] Empirical macroeconomic forecasting models, being based on roughly the same data, had similar implications: they suggested that unemployment could be permanently lowered by permanently increasing inflation. recursive DSGE models often assume that all agents of a given type are identical (i.e. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. Write down the recurrence that relates subproblems 3. The chapter covers both the deterministic and stochastic dynamic programming. u. These include aggregate … As a –rst economic application the model will be enriched by … Thus, these models grew to include hundreds or thousands of equations describing the evolution of hundreds or thousands of prices and quantities over time, making computers essential for their solution. Dynamic programming In mathematics and computer science, dynamic programming is a method for solving complex problems by breaking them down into simpler subproblems. Abstract: This is intended as a very basic introduction to the mathematical methods used in Thomas Sargent's book Dynamic Macroeconomic Theory. there is a ‘representative household’ and a ‘representative firm’) and can perform perfect calculations that forecast the future correctly on average (which is called rational expectations). However, economic forecasting is still largely based on more traditional empirical models, which are still widely believed to achieve greater accuracy in predicting the impact of economic disturbances over time. MIT OpenCourseWare is a free & open publication of material from thousands of MIT courses, covering the entire MIT curriculum.. No enrollment or registration. The ABCs of RBCs. The stagflation of the 1970s appeared to bear out their prediction.[11]. ABCs of RBCs : An Introduction to Dynamic Macroeconomic Models, Hardcover by McCandless, George T., ISBN 0674028147, ISBN-13 9780674028142, Brand New, Free shipping in the US The first book to provide a basic introduction to Real Business Cycle (RBC) and New-Keynesian models is designed to teach the economic practitioner or student how to build simple RBC models. A Simple Introduction to Dynamic Programming in Macroeconomic Models Ian King* Department of Economics University of Auckland Auckland New Zealand April 2002 (October 1987) Abstract This is intended as a very basic introduction to the mathematical methods used in Thomas Sargent's book Dynamic Macroeconomic Theory. A closely related methodology that pre-dates DSGE modeling is computable general equilibrium (CGE) modeling. 1.1 Basic Idea of Dynamic Programming Most models in macroeconomics, and more speci fically most models we will see in the macroeconomic analysis of labor markets, will be dynamic, either in discrete or in continuous time. This work is an extension of the work by Nathan Forrester on the use of basic macroeconomic theory to stabilize policy analysis. Welcome! Abstract. [17] Compared with empirical forecasting models, DSGE models typically have fewer variables and equations, mainly because DSGE models are harder to solve, even with the help of computers. This is one of over 2,200 courses on OCW. An Introduction to Dynamic Macroeconomic Models, Harvard The variables that appear in these models often represent macroeconomic aggregates (such as GDP or total employment) rather than individual choice variables, and while the equations relating these variables are intended to describe economic decisions, they are not usually derived directly by aggregating models of individual choices. King, Ian, 2002. The model was cited in 1980 when Klein, like Tinbergen before him, won the Nobel Prize. Dynamic programming is an optimization approach that transforms a complex problem into a sequence of simpler problems; its essential characteristic is the multistage nature of the optimization procedure. It contains sections on deterministic finite horizon models, deterministic infinite horizon models, and stochastic infinite horizon models. Like DSGE models, CGE models are often microfounded on assumptions about preferences, technology, and budget constraints. Blanchard, Olivier (2000), op. Examples include the IS-LM model and Mundell–Fleming model of Keynesian macroeconomics, and the Solow model of neoclassical growth theory. In the 1940s and 1950s, as governments began accumulating national income and product accounting data, economists set out to construct quantitative models to describe the dynamics observed in the data. [3] The first global macroeconomic model, Wharton Econometric Forecasting Associates' LINK project, was initiated by Lawrence Klein. It takes you through the computational part of RBC with a lot of examples and code, I totally recommend it for the ones who which to start programming the macro models the … [3] These models estimated the relations between different macroeconomic variables using (mostly linear) time series analysis. Find materials for this course in the pages linked along the left. DSGE and ACE models have different advantages and disadvantages due to their different underlying structures. [27] Given these strategies, the interaction of large numbers of individual agents (who may be very heterogeneous) can be simulated on a computer, and then the aggregate, macroeconomic relationships that arise from those individual actions can be studied. The numbers along the middle layer are … The course evaluation is based on a midterm, a final and weekly homeworks. However, these are only simplifying assumptions, and are not essential for the DSGE methodology; many DSGE studies aim for greater realism by considering heterogeneous agents[16] or various types of adaptive expectations. Instead of defining the preferences of those agents, ACE models often jump directly to specifying their strategies. These models begin by specifying the set of agents active in the economy, such as households, firms, and governments in one or more countries, as well as the preferences, technology, and budget constraint of each one. More so than the optimization techniques described previously, dynamic programming provides a general framework for analyzing many problem types. This chapter provides a succinct but comprehensive introduction to the technique of dynamic programming. “A Simple Introduction to Dynamic Programming in Macroeconomic Models,” mimeo, University of Auckland. Steps for Solving DP Problems 1. However, CGE models focus mostly on long-run relationships, making them most suited to studying the long-run impact of permanent policies like the tax system or the openness of the economy to international trade. Ljungqvist, L. and Sargent, T. (2012). While the choice of which variables to include in each equation was partly guided by economic theory (for example, including past income as a determinant of consumption, as suggested by the theory of adaptive expectations), variable inclusion was mostly determined on purely empirical grounds. It gives us the tools and techniques to analyse (usually numerically but often analytically) a whole class of models in which the problems faced by economic agents have a recursive nature. macroeconomic models, structural labor models, or even microeconomic dynamic games. In the context of the Phillips curve, this means that the relation between inflation and unemployment observed in an economy where inflation has usually been low in the past would differ from the relation observed in an economy where inflation has been high. Now I should introduce dynamic programming in more formal settings. 2.1 The model The model consists of some simple equations: These models share several features. [18] Simple theoretical DSGE models, involving only a few variables, have been used to analyze the forces that drive business cycles; this empirical work has given rise to two main competing frameworks called the real business cycle model[19][20][21] and the New Keynesian DSGE model. Macroeconomic models, such as STMs, are composed of diagrams and/or equations and deal with several variables. Recognize and solve the base cases ... n’s don’t relate in simple … [5][6][7], Econometric studies in the first part of the 20th century showed a negative correlation between inflation and unemployment called the Phillips curve. A macroeconomic model is an analytical tool designed to describe the operation of the problems of economy of a country or a region. On the other hand, ACE models may exaggerate errors in individual decision-making, since the strategies assumed in ACE models may be very far from optimal choices unless the modeler is very careful. The ABCs of RBCs is the first book to provide a basic introduction to Real Business Cycle (RBC) and New-Keynesian models. There are 20 ways. Of more general dynamic constraints encountered in economic applications and budget constraints the main reference be... 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Course in the three-part 416 series are dynamic, describing the economy over many time periods 4 ], economist... To specifying their strategies — Introduction to dynamic programming in macroeconomic models, such STMs... Aggregate macroeconomic relationships into microeconomic decisions of individual agents finite horizon models, ” mimeo, University of Auckland are... In Simple … Notes on macroeconomic Theory, 3rd Edition, MIT.! [ 4 ], Dutch economist Jan Tinbergen developed the first in the pages linked along the left argued this... Mostly linear ) time series analysis stagflation of the 1970s appeared to bear out their.. Are static, but some are dynamic, describing the economy over many time.! ( mostly linear ) time series analysis on the use of Julia is a fantastic choice for teaching modern methods. The 1970s appeared to bear out their prediction. [ 11 ], especially Forecasting. The University of Pennsylvania `` Julia is a computer language that is taking Economics by..
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