1. Econ 208 Marek Kapicka Lecture 1 Introduction

2. What is this course about? Analysis of macroeconomic policies Government Spending Taxation and government debt Monetary policy Banking and financial intermediation We will use micro-founded macroeconomic models to study those issues

3. Administration Classes: MW 9:30-10:45 My email: mkapicka@econ.ucsb.edumkapicka@econ.ucsb.edu Office hours: TTh 10:30-11:30, NH 3052 Course homepage: http://econ.ucsb.edu/~mkapicka/E208.html

4. Administration TA Xintong Yang (lemon0215@gmail.com) TA sessions: Thursdays 3:00-3:50 & 4:00- 4:50 GIRV 1116 Textbook Macroeconomics, by Matthias Doepke, Andreas Lehnert, and Andrew Sellgren

5. Administration 5 problem sets 4 best ones count 25 % of the final grade Midterm (May 6, in class) No make-up 25 % of the final grade Closed book, closed notes Final (June 12, 9-11) 50 % of the final grade Closed book, closed notes

6. Outline of the course 1. Introduction: A basic framework 2. Government Policies 1. The Effects of Government Spending 2. Government Taxation and Government Debt 3. Monetary Policy 4. Banking and Financial Intermediation

7. Per Capita Real GDP (in 2000 dollars) for the United States, 1900-2008

8. Growth rates If g t is small,

9. Natural Logarithm of Per Capita Real GDP

10. The Great Recession

11. 1981-1982 Recession

12. 1. US GDP, Consumption, and Government Expenditures

13. 2. Total Taxes (black line) and Total Government Spending (colored line) in the United States, as Percentages of GDP

14. 2. Recent Recession: Fiscal Policy 2009 Fiscal Stimulus: $787 billion (~5.5% of GDP) Tax cuts: $288 billion Spending on Healthcare & Education: $238 billion Infrastructure: $81 billion

15. 4. US History of banking crises Before 1914: Crises were a frequent phenomenon in the U.S. National banking era 1863-1913 They have occurred at about 10 year intervals 1873,1884,1890,1893,1896,1907,1914

16. U.S. National Banking Era Panics

17. 2. How do we study macro? We cannot run experiments in macroeconomics, so we need to construct models to be used as laboratories

18. Prague

19. A map of Prague

20. A map of Prague subway

21. How do we study macro? A good model: Simplified, abstract, representation of reality Omits many details, represents only essential features needed to answer a specific question helpful to make predictions should be simple, but they need not be realistic.

22. 2.1 Structure of a typical model Households Choose consumption, saving, labor supply Firms Choose production, investment, labor demand Markets Prices such that Supply = demand

23. 2.1 Structure of a typical model 1. Description of goods in the economy 2. Consumers preferences over goods 3. Firms technology available to produce the goods 4. The resources available

24. 2.2 Prediction of a Model Individual behavior people behave rationally (optimize) firms maximize profits Equilibrium behavior competitive equilibrium

25. 2.3 Microeconomic Foundations The Approach 1. Start with consumers and firms making decisions at individual level 2. Aggregate them up Representative Consumer Assumption Example: Benefits of this Approach 1. Monetary Policy

26. A Basic Intertemporal Model A simple model where people choose how much to consume and how much to save A) Consumer Optimization B) Market Clearing C) Adding capital stock D) Welfare Theorems E) Infinite horizon

27. A Basic Intertemporal Model First period = current period Second period = future period To simplify, abstract from labor/leisure decision Our interest: borrowing and saving by consumers

28. A Basic Intertemporal Model Preferences of consumers U(c) is increasing, differentiable and concave Discount factor β<1 measures how much future utility matters relative to current utility

29. A Basic Intertemporal Model Budget Constraints: y 1, y 2 are exogenous incomes b 1 are savings from period 1 to period 2 r is the interest rate

30. Consumer’s optimization Consumers maximize utility subject to budget constraints Lagrangean

31. Consumer’s optimization First order conditions Euler Equation

32. A) Consumer’s optimization Log utility: Solution:

33. Where are we? A Basic Intertemporal Model A) Consumer Optimization B) Market Equilibrium C) Adding capital stock D) Welfare Theorems E) Infinite horizon

34. B) Market Equilibrium Suppose that there is N identical agents Market clearing condition is Log utility: