PONTIFICIA UNIVERSIDAD CATÓLICA

PROGRAMA: MAESTRÍA DE ECONOMÍA

CURSO: MACROECONOMÍA AVANZADA - MÓDULO 1
NOTAS DE CLASES: Alex Contreras - Jesús Ramírez
1. Optimality Conditions under Non-Separable Leisure
1 1
U (Ct ; Nt ) = [Ct (1 Nt ) ]
1
Marginal utilities
Uc;t = [Ct (1 Nt ) ] (1 Nt )
Un;t = [Ct (1 Nt ) ] Ct (1 Nt ) 1
Optimality conditions are
Un;t Wt
=
Uc;t Pt
and
Uc;t+1 Pt
Qt = Et
Uc;t Pt+1
substituting marginal utility of consumption
Ct Wt
=
(1 Nt ) Pt
and marginal( (dis)utility of labor )
[Ct+1 (1 Nt+1 ) ] (1 Nt+1 ) Pt
Qt = Et
[Ct (1 Nt ) ] (1 Nt ) Pt+1
( )
(1 )
Ct+1 1 Nt+1 Pt
Qt = Et
Ct 1 Nt Pt+1
log-linearization
taking logs
ln + ln Ct ln (1 Nt ) = ln Wt ln Pt
ln + ct ln (1 exp nt ) = wt pt
…rst Taylor’s expansion
N
ln (1 exp nt ) = ln (1 N ) (nt n)
(1 N )
N N
ln (1 exp nt ) = ln (1 N ) + n nt
(1 N ) (1 N )
substituting
N
& + ct + nt = wt pt
(1 N )
N
& = ln ln (1 N ) n
(1 N )
Euler’s (equation )
(1 )
1 Ct+1 1 Nt+1 Pt
1 = Et
Qt Ct 1 Nt Pt+1
( )
(1 )
1 exp nt+1
1 = Et exp (it 4ct+1 t+1 )
1 exp nt
where
= ln
it = ln Qt

1
In perfect foresight steady state with constant in‡acion , constant growth and constant
level of employment n
i= + +
First-order Taylor expansion of xxx around that steady state
(1 )
1 exp nt+1
F (z) = exp (it 4ct+1 t+1 )
1 exp nt
z = (it ; 4ct+1 ; t+1 ; nt+1 ; nt )
partial derivatives
(1 )
1 exp nt+1
Fi;t (z) = exp [it 4ct+1 t+1 ]
1 exp nt
(1 )
1 exp nt+1
F4c;t+1 (z) = exp [it 4ct+1 t+1 ]
1 exp nt
(1 )
1 exp nt+1
F ;t+1 (z) = exp [it 4ct+1 t+1 ]
1 exp nt
(1 )
1 exp nt+1 exp nt+1
Fn;t+1 (z) = (1 ) exp [it 4ct+1 t+1 ]
1 exp nt 1 exp nt+1
(1 )
1 exp nt+1 exp nt
Fn;t (z) = (1 ) exp [it 4ct+1 t+1 ]
1 exp nt 1 exp nt
First-order Taylor expansion of F (z) around z = (i; 4c; ; n; n) is given by
F (z) ' F (z)+Fi;t (z) (it i)+F4c;t+1 (z) (4ct+1 )+F ;t+1 (z) ( t+1 )+Fn;t+1 (z) (nt+1 n)+
Fn;t (z) (nt n)
But,
F (z) = Fi;t (z) = F ;t+1 (z) = 1
and
F4c;t+1 (z) =
N
Fn;t+1 (z) = Fcm;t+k (z) = (1 )
1 N
Combining xx with xx

F (z) ' 1 + (it i) (4ct+1 ) ( t+1 ) 4nt+1

F (z) ' 1 + it 4ct+1 t+1 4nt+1

substituting
1 = Et f1 + it 4ct+1 t+1 4nt+1 g
1
ct = Et fct+1 g (it Et f t+1 g ) + (Et fnt+1 g nt )
…nally
N
& + ct + nt = wt pt
(1 N )
1
ct = Et fct+1 g (it Et f t+1 g )+ (Et fnt+1 g nt )

2. Alternative Interest Rules for the Classical Economy

Equilibrium relationship
1
yt = Et fyt+1 g (it Et f t+1 g )

2
Real interest rate
rt = + Et f4yt+1 g
Fisherian equation
it = Et f t+1 g + rt
Money market clearing condition
mt pt = yt it + mt
a) Strict In‡ation Targeting
i)
Interest rate rule
it = + ( t ); > 1
substituting RIR and IRR into FE
( t ) = Et f t+1 g + rt
t = + 1 Et f t+1 g + 1 r^t
leading one period ahead and taking expectationg twice
1
Et t+1 = 1 + 2 Et f t+2 g + 2 Et f^ rt+1 g
2 2 3 3
Et t+2 = + Et f t+3 g + Et f^rt+2 g
.
.
.
n
Et t+n = n + n 1 Et f t+n+1 g + n 1 Et f^ rt+n g
sum up and taking limit
Xn X
n
j n 1 j 1
t = + Et f t+n+1 g + Et f^
rt+j g
j=0 j=0
X
1 X
1
j n 1 j 1
lim t = + lim Et f t+n+1 g + Et f^
rt+j g
n!1 n!1
j=0 j=0
X
1
j 1
t = + Et f^
rt+j g
1 j=0
completed stabilization
X1
j 1
lim t = lim + lim Et f^rt+j g
!1 !1 1 !1
j=0
t =
ii)
substituting into money market clearing condition
mt pt = yt [ + ( t )] + m t
mt = yt + (1 ) pt + pt 1 + [ ]+ m t
4mt = 4yt + (1 )4 t + 4 t 1+4 m t
in completed stabilization
4mt = 4yt + 4 m t
iii)
constant rate of money growth
4mt =
it = 1 ( m t + p t + y t + m t )
1
( mt + pt + yt + m t ) = Et fpt+1 g pt + rt
1
(1 + ) pt = Et fpt+1 g + 1 mt + rt 1
yt 1 m
t

3
 1 1 1 m
pt = Et fpt+1 g + mt + ( rt yt ) t
1+ 1+ 1+ 1+
where
1
ut = ( rt y t )
1+
solving by rational expectations
1 X X 1 X
1 j 1 j 1 j
m
pt = Et fmt+j g+ Et fut+j g Et t+j
1 + j=0 1 + j=0
1+ 1 + j=0 1+
where1
X j
u~t = Et fut+j g
j=0
1 +
1 X
1 j
~mt = Et m t+j
1 + j=0 1 +
substituting into last equation
1 X
1 j
pt = Et fmt+j g + u~t + ~mt
1 + j=0 1 +
1 X
1 j
pt = mt + Et f4mt+j g + u~t + ~m
t
1 + j=0 1 +
where
4mt+j = mt+j mt
from money growth rule
4mt =
4mt+j = j
substituting into last equation
X 1 j
pt = mt + j + u~t + ~mt
1 + j=0 1 +
series formula
X 1
j
j=
j=0
(1 )2
substituting
pt = mt + + u~t + ~mt
taking di¤erences
4pt = 4mt + 4~ ut + 4~m t
t = + 4~ ut + 4~m t
b)Price Level Targeting
i)interest rate rule
it = + p (pt p ) ; p > 0 and p is constant
new version of FE
it = Et f^ pt+1 g p^t + rt
where price deviation from price level target every period is de…ned
p^t+n = pt+n p ; 8n 0
from above
it = + p p^t
substituting into NFE

4
 pp
^t = Et f^
pt+1 g p^t + r^t
1 + p p^t = Et f^pt+1 g + r^t
1 1
p^t = 1 + p Et f^
pt+1 g + 1 + p r^t
solving by rational expectation
X1
j 1
p^t = 1+ p Et f^rt+j g
j=0
ii)money targeting rule
mt = p
substituting into money market clearing condition
it = 1 ( p + p t + y t + m t )
it = 1 (^ pt + yt + m t )
replacing in NFE
p^t + yt + mt = Et f^ pt+1 g p^t + rt
m
(1 + ) p^t = Et f^ pt+1 g + rt yt t
1 1 m
p^t = Et f^
pt+1 g + ( rt y t )
1+ 1+ 1+ t
where
1
ut = ( rt y t )
1+
solving by rational expectations
X1 j
1 X
1 j
m
p^t = Et fut+j g Et t+j
j=0
1+ 1 + j=0 1 +
iii)
it = + 1 (pt p ) + 1 (yt + m t )
it = + (pt p ) + ut
where
ut = 1 (yt + m t )
1
=
iv)central bank wants to minimize the volatility of price level
case i)
X
1
j 1
p^t = 1+ p Et f^
rt+j g
j=0
case ii)
X
1 j
1 X
1 j
m
p^t = Et fut+j g Et t+j
j=0
1+ 1 + j=0 1 +
real interest rate evolve accordingly to
r^t = ya (1 a ) at
and technological shock accordingly to
at = a at 1 + "at
and money demand disturbance accordingly to
m m m
t = m t 1 + "t
j-step ahead real interest rate
r^t+j = ya (1 a ) at+j
taking expectation

5
 j
Et r^t+j = ya (1 a ) a at
substituting into price equilibrium relationship
ya (1 a)
X 1 j
a
p^t = at
1+ p j=0
1+ p
ya (1 a)
p^t = at
1+ p a
in the case ii), the evolution of ut
1
ut = ( rt y t )
1+
depends of evolution of rt
rt = ya (1 a ) at
and yt
yt = ya at + #y
substituting into ut
1
ut = ya (1 a ) at ya at + #y
1+
1
ut = ( #y ) [ (1 a ) + 1] ya at
1+
j-step ahead of ut and taking expectations
1 j
Et fut+j g = ( #y ) [ (1 a ) + 1] ya a at
1+
substituting into price equilibrium relationship
#y X X X
1 j 1 j 1 j
[ (1 a ) + 1] ya a 1 m m
p^t = at t
1+ j=0
1+ 1+ j=0
1+ 1+ j=0
1+
[ (1 a ) + 1] ya 1 m
p^t = #y at t
1 + (1 a) 1 + (1 m)

3. Nonseparable Preferences and Money Superneutrality

1
1 1 1 v
Nt1+'
U Ct ; M
Pt
t
; Nt = (1 #)Ct1 v +# Mt
Pt 1+'
1

(a)
Marginal utilities
v
1 1 v
Uc;t = (1 #)Ct1 v +# Mt
Pt
(1 #)Ct v

v
1 1 v
v
U M ;t = (1 #)Ct1 v +# Mt
Pt
(#) M
Pt
t
P

UN;t = Nt'
Optimality conditions are

Labor supply
Un;t Wt
=
Uc;t Pt

6
 Nt' Wt
v =
(1 #)Ct1 v
+#
Mt 1 1 v
(1 #)Ct v Pt
Pt

Euler’s equation

Uc;t+1 Pt
Qt = Et
Uc;t Pt+1
8 v 9
>
> 1 v Mt+1
1 1 v
v >
>
>
< (1 #)Ct+1 +# Ct+1 >
Pt+1 Pt =
Qt = Et v
>
> 1 1 v Pt+1 >
>
>
: (1 #)Ct1 v + # Mt
Ct v >
;
Pt
8 v 9
>
> 1 v Mt+1
1 1 v
v >
>
>
< (1 #)Ct+1 + # Ct+1 >
1
Pt+1 Pt =
1+it
= Et v
>
> 1 1 v Pt+1 >
>
>
: (1 #)Ct1 v + # Mt
Ct v >
;
Pt

demand of money
it
U M ;t = Uc;t 1+i t
P
Mt 1 1
Pt
= ( 1 # # ) v Ct ( 1+i
it
t
) v

Assumptions
Yt = Nt

Under perfect competition:

Pt = M gCt marginal cost

Where:
T Ct : Total cost
T Ct = Wt Nt = Wt Yt

M gCt = @T@YCt = Wt
t
In perfect competition, and under the asumption that:Yt = Nt :

Pt = W t
1= W t
Pt

(b) Steady state

Labor supply

N' W
h iv = =1
(1 #)C 1 v +# M
( )
1 1 v
(1 #)C v P
P

Euler’s equation

7
 h i v1
M 1 v
(1 #)C 1 v
+# P
C v
P
1
1+i
= h i v1
M 1 v P
(1 #)C 1 v +# P
C v

1
1+i
=

demand of money
M 1 1
P
= ( 1 # # ) v C( 1+i
i
) v
Aditional restrictions
Y =N

(c)

Under the assumption Y = C

h i v1
M 1 v
N ' = (1 #)C 1 v
+# P
(1 #)C v

h i v1
'+v 1 v M 1 v
Y = (1 #) (1 #)C +# P

M
A increase in P
has permanent e¤ects in Y:

4. Optimal Monetary Policy in a Classical Economy with an Exact Equilibrium Represen-

tation
Nt1+'
U Ct ; M
Pt
t
; Nt = log(Ct ) + log( M
Pt
t
) 1+'

(a)
Households Problem
Marginal utilities
Uc;t = C1t
U M ;t = M1t
P Pt
UN;t = Nt'
Optimality conditions are

Labor supply
Un;t Wt
=
Uc;t Pt

Nt' Wt
( C1 )
=
t Pt
' Wt
Ct Nt =
Pt
Euler’s equation

8
 Uc;t+1 Pt
Qt = Et
Uc;t Pt+1
( 1 )
Ct+1 Pt
Qt = Et 1
Ct
Pt+1
1 Ct Pt
1+it
= Et
Ct+1 Pt+1

demand of money
it
U M ;t = Uc;t 1+i t
P
1 1 it
Mt = C ( 1+i )
t t
Pt
Mt it 1
Pt
= Ct ( 1+i t
)

Firm Problem

Function of production
Y t = At Nt

Demand of labor
Wt @Yt
Pt
= @N t
= At
Wt
Pt
= At
(b)

Wt
Ct Nt' =
Pt
Yt '
Yt ( At ) = At
Yt1+' = A1+'
t

Where:

Yt = At (Output of equilibrium)
Yt = Ct

Ct = At (Consumption of equilibrium)
Y t = At Nt
Nt = 1 (Labor of equilibrium)
Wt
Pt
= At (real wage of equilibrium)

Of Euler equation:
1 Ct Pt
1+it
= Et
Ct+1 Pt+1
Ct Pt
1 = Et (1 + it )
Ct+1 Pt+1

9
 Ct
1 = Et (1 + rt )
Ct+1
At
1 = Et (1 + rt )
At+1
( )
1 1
(1+rt )
= Et
(1 + a ) exp "at+1
1
8 9 1 = rt (Real interest rate of equilibrium)
< 1 =
Et
: (1 + a ;
a ) exp "t+1

Of demmand of money:
Mt it
Pt
= Ct ( 1+i t
) 1
it
Mt ( 1+i t
) = Ct Pt
it
Supose: Vt = 1+i t
= V (constant)

Mt Vt = Ct Pt
Mt Vt = Yt Pt

Mt Vt = At Pt
M t V = At P t
M t 1 V = At 1 P t 1

Mt At Pt
Mt 1
= At 1 Pt 1

m a Pt
(1 + m ) exp f"t g = (1 + a ) exp f"t g Pt 1
m
(1+ m ) expf"t g
(1+ a ) expf"a
= t
tg

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