Dynamic Economics in Practice

28 and 29 October 2013, UCL Economics Department.

Course Tutors: Monica Costa Dias (IFS) and Cormac ODea (IFS)

Course Overview
This course provides a practical introduction to solving microeconomic dynamic optimisation
problems. It will ground the discussion around the life-cycle permanent income model of
consumption and savings, a model that has been a key workhorse in both macro- and microeconomics. The course has two main goals.
The first goal is to provide a rigorous discussion of recursive methods and how they are used to
solve dynamic optimization problems in economics. We will show that the optimal allocation of
resources over time depends on key characteristics of the problem at hand, including individual
preferences, the dynamics of income or other resources, and economy-wide characteristics
determining, for instance, the amount of uncertainty faced by individuals or the functioning of
insurance and credit markets. The simplest consumption-savings problem will be introduced first
and used to discuss the key features of recursive solution and simulation methods. It will then be
gradually extended to more realistic, but also more complex setups.
The second goal is to discuss and implement the numerical tools typically used to solve and simulate
dynamic optimisation problems. Recursive methods provide a powerful framework for the
numerical solution of dynamic problems and computational algorithms heavily rely on them. The
tight connection between the recursive solution methods and the numerical approach to the
solution and simulation of the problems will be highlighted. We will examine numerical techniques
to solve equations and approximate, interpolate, integrate and optimise unknown functions
showing, in each case, the relative strengths and weaknesses of alternative techniques. The
numerical tools will then be combined to solve and simulate problems of different levels of
complexity. We will discuss how to use information about the problem to improve the accuracy of
numerical approximations.
The course is a mixture of lectures and applied sessions. Course participants will apply the various
techniques on their computers using MATLAB, based on accompanying code developed to
implement the solution and simulation routines.

Required level of knowledge

This is an intermediate-level course that offers a formalised analysis of dynamic optimisation
problems and solutions methods. It requires some previous knowledge of economic problems and
optimisation methods, as well as a sound mathematical background.

The practical part of the course will use MATLAB. Although prior knowledge of MATLAB is not
required, as it will be introduced for beginners and all exercises will be guided, some prior
experience with some computer software for data analysis or a programming language is
recommended to ensure participants can follow a relatively quick introduction to a new language.

References and readings

The material covered in the course combines contributions that can be found in more than one
book. The practical focus is similar to that found in Adda and Cooper (2003). The discussion of the
life-cycle consumption problem and of recursive methods in economics follows Ljungqvist and
Sargent (2004). A more formal account can be found in Stokey and Lucas (1989). Finally, much of
the numerical detail uses Judd (1998). Full references are:
Adda, Jerome and Russell Cooper (2003). Dynamic Economics. Cambridge : MIT Press.
Judd, Kenneth (1998). Numerical Methods in Economics. Cambridge : MIT Press.
Ljungqvist, Lars and Thomas Sargent (2004). Recursive Macroeconomic Theory. 2nd Edition.
Cambridge : MIT Press.
Stokey, Nancy and Robert Lucas (1989). Recursive Methods in Economic Dynamics. Cambridge:
Harvard University Press.

Fees
Students, 60.00; Academics/Charities/Public Sector employees, 120; Others, 440.
Book online via the PEPA website at www.pepa.ac.uk.

If you have any questions please contact the PEPA administrator at enquiries@pepa.ac.uk or on
02072914821. PEPA is a node of the National Centre for Research Methods and is PEPA is hosted by
the Institute for Fiscal Studies and cemmap.