Chapter 13: Modern Macroeconomic Models 136
CHAPTER 13
Modern Macroeconomic Models
TEACHING OBJECTIVES
Goals of Chapter 13
A. Examine two main approaches economists have developed to build
macroeconomic models during the past 20 years.
B. The first approach begins with economic theory to build a better
economic model. The improvement comes from better descriptions of
TEACHING NOTES
A. Dynamic Models
1. Introduction
a) A dynamic model is one in which actions that occur at one time
a#ect what happens at other times; a static model focuses on
what happens at one point in time
b) Dynamic models allow economists to model how people form
expectations
c) Dynamic models also allow an examination of how people are
affected by policy actions by describing the microeconomic
foundations of the macroeconomy
Chapter 13: Modern Macroeconomic Models 137
period, given a household’s budget or income, which depends
on how much a person borrows or lends; use Figure 13.1
(2) A person’s preferences determine how much the person
consumes in each period
c) A change in income affect consumption
(1)An increase in income shifts the budget constraint to the right
(Figure 13.2); a decline in income shifts the budget constraint
to the left
(2) A household that initially borrows is better o# if the
interest rate declines; a household that had initially planned to
save is probably worse o#
(3) The slope of the budget constraint is −( 1 + i ).
e) Consumption depends on lifetime income, not just income in the
current period
3. General Equilibrium
a) Once we know how each person acts in the model, we can find the
economy’s general equilibrium, which occurs when all markets
are in equilibrium and all economic agents make decisions in their
own best interest
b) An example with a given number of people who are rich (with
higher incomes) and a given number who are poor (with lower
incomes) illustrates how general equilibrium is calculated
c) General equilibrium requires that total savings of people who save
4. Expectations
a) Expectations are people’s beliefs about future economic
variables; if people form those beliefs using all the information
available to them, they have rational expectations
b) Some expectations pertain to an individual: for example, a
person’s expectations about her own future income
Chapter 13: Modern Macroeconomic Models 138
c) Other expectations pertain to the economy as a whole: for
example, a person’s expectations about the future inflation rate
d) A model of expectations must describe how people form their
expectations about policies that a#ect them, such as how
monetary policy is formulated and is likely to change in the future
5. The Impact of Changes in Government Policy
a) Consider the example of a tax rebate that the government gives
people in period 1, which is financed by a tax increase in period 2
B. Policy Insider: Tax Cuts and Consumer Spending
1. A test of the theory came in 2001 when the government gave tax
rebates to try to stimulate the economy
2. The University of Michigan’s Survey Research Center, conducted a
research to find out the number of taxpayers who would spend the
rebate checks compared to the number that planned to save.
3. The survey results suggests that, in 2001, the tax rebates had very
little impact on consumer spending, supporting the notion of Ricardian
equivalence
C. Dynamic, Stochastic, General-Equilibrium Models
1. Following the failure of the large, structural macroeconomic models of
the 1970s, economists began to build models called dynamic,
stochastic, general-equilibrium (DSGE) models, of which there
are several types
2. Real Business-Cycle (RBC) Models
a) In real business-cycle (RBC) models, the level of total factor
productivity is the engine of economic growth and :uctuations of
total factor productivity are the source of business cycles
Chapter 13: Modern Macroeconomic Models 139
e) The main policy implication of RBC models is that government
policy should be set predictably so as not to interfere with
economic growth
3. Modern DSGE Models
a) Newer DSGE models build on RBC models but add more shocks,
not just shocks to total factor productivity, and allow a greater role
for government policy
D. Statistical Models of the Economy
1. Some models of the economy avoid any description of the economy’s
structure and merely focus on the statistical relationships between
macroeconomic variables
2. One type of model is a univariate time-series model, in which a
variable’s value today depends only on its own past
3. Forecasts from such models are often quite good, and many times are
superior to those from structural models
4. A more complicated statistical model is a vector autoregression
(VAR) model, in which the value of a variable depends on its own
past and the past of other variables, but in which a particular
E. Policy Perspective: Do Modern Macroeconomic Models Have Any Value for
Policy?
1. Large, structural macroeconomic models and VARs have trouble
analyzing policy changes because of the Lucas critique—policy
changes are likely to cause the equations of the models to change,
making them useless
2. But most policy changes do not significantly a#ect the equations of
the models, according to Sims, so analyzing policy changes can be
Chapter 13: Modern Macroeconomic Models 140
4. Short-run restrictions in a structural VAR describe the impact of
one variable on another in the short run; long-run restrictions
describe the impact of one variable on another in the long run
5. Recent research with structural VARs gives a more precise estimate of
the impact of monetary policy than previous research did
6. New research on DSGE models also provides estimates of the impact
of policy on economic variables and shows how government policy
may be used to stabilize the economy; refer students to the box on
The New Neoclassical Synthesis
F. The New Neoclassical Synthesis
1. New research on DSGE models has developed models with a role for