The Model Student

Recent sessions have looked at fluctuations of the economy around long run trends, encompassing both real and financial cycles. So far, domestic variables have been the focus of attention. Issues such as trade, global value chains, exchange rates and cross-border capital flows are being left for Sessions 12 and 13.

Our modelling of cycles started with core concepts such as the output gap and real interest rates. And we reviewed key relationships including the Phillips Curve, which links inflation to the output gap.

In strengthening modelling skills, we have recognised the importance of dynamics, whether shocks are short- or long-lived and how those shocks might be propagated through the economy. Cyclical stability is not necessarily a given and even if mean reversion takes place, the journey could be long and arduous – perhaps leaving permanent scars. We called that trend-cycle interaction “hysteresis”.

Indeed, markets left to their own devices often generate unacceptable outcomes for society. So, we look to governments and their agencies to guide events in more favourable directions. In studying stabilisation policies such as fiscal policy, monetary policy and macro-financial policy we have found plenty to keep public officials busy – on both the demand and supply-side of the economy.

Certainly, one of the frequent takeaways in recent sessions is that the macro economy is far from easy to analyse – there are so many moving parts. It is no surprise then that forecasts can sometimes be very wide of the mark and “what-if” exercises (simulations) are but a tiny sample of the range of possibilities.

But that does not mean that we should not try. That is why we use models – to help simplify and focus on the essentials. To see the wood for the trees. To improve our chances – in a highly uncertain and complex world – of making good decisions, either as private individuals or companies, or as policymakers. Our models have so far been relatively simple, involving limited algebra and generally making use of diagrams. Impulse response functions were especially illuminating for dynamic processes such as multiplier-accelerator interactions. But the key graphical workhorses for AD-AS analysis comprise,

  • Curves in real interest rate/output gap space – the IS and TR curves of Sessions 8 and 10 respectively
  • Curves in inflation/output gap space, such as the Phillips curve of Session 6 – a proxy for aggregate supply. There is another curve we need, an aggregate demand (AD) curve that has yet to be tackled

So, Session 11 not only reviews where we have got to but also fills in the gaps. By the end of this session you will be a fully-fledged AD-AS Model Student.

Following a review of IS and TR curves, including reminders about slopes and shifts, we construct the missing AD curve. The good news is that this curve simply combines the interaction of IS and TR curves and maps outcomes into inflation/output gap space. We take time and care to examine its slope, shifts and dynamics.

As for the AS curve we have already done some groundwork with a simple Phillips relationship. However, there is more to do. We recall that in practice, inflation and prices tend to sticky – not terribly responsive to the state of the business cycles. We look at a model of sticky prices that brings into play a core variable for us – inflation expectations. Expectations are a central feature of modern macro models and are the means by which perceptions about the future – sometimes fickle and irrational – can influence the present.

Once having considered a more general form of the AS curve (the accelerationist Phillips curve) and broadened our understanding of inflation expectations, we then have all the necessary elements to perform some intermediate AD-AS analysis.

We start by looking at a very simple closed economy model comprising four equations which you can solve manually and play around with in Excel. This model is usually the basis of in-class discussions and student presentations.

We finish by moving up a gear, seeking to apply AD-AS analysis to the Covid-19 crisis. Here we appreciate the benefits of more complex software available to macroeconomists and make more extensive use of impulse response functions. The IS/TR and AD/AS workhorses can only go so far as informative graphical tools.

When we gear up further, adding many more moving parts from international trade and finance, IRFs come into their own as a better graphical choice ahead of finishing the course, in Session 14, by looking at cutting-edge macro models used by top academics, Wall Street researchers and policymakers.

12 Nov 2020

Money & Finance

Session 7 dips into the murky waters of money and finance. Oceans of uncertainty; troubled waters, a rareness of calm. We are journeying far from the safe and certain world of Solow!

One thing for sure is that macro without finance is Hamlet without the Prince.  Finance predates industrial revolutions and has been the essence of economic life since time immemorial. Finance is one of the core components of TFP – bad finance invariably means bad growth outcomes. Finance delivered the GFC (Great Financial Crisis) – an early defining moment of the 21st century. So the first key takeaway from this session is that there is no dichotomy between the real economy and the financial world. Main Street is joined at the hip with Wall Street; you cannot divorce what happens in the real sector from what is going on in the money sector.  Indeed we shall find that financial yield curves (or term spreads as they are sometimes known) can be useful leading indicators of real economy business cycles.

In discussing finance we need to identify the key players (basically everyone!) and acknowledge that money and credit are flip sides of the same coin. Credit – or debt if you are looking at it from the point of view of the borrower – is good. Living standards depend on the ability of households to smooth their consumption over time. Companies would not be able to lift society onto higher growth paths unless credit was available to implement good ideas and diffuse new technology.

Another key takeaway is that bubbles – speculative and maybe unsustainable asset price booms – are a necessary evil. Bubbles are a way of mobilising capital when the world is full of radical uncertainty and incomplete markets. The alternative is that the State would do the heavy lifting in terms of financing and promoting new ideas. Possible, but an unlikely and arguably an unhealthy way of economic life.

But you can have too much of a good thing. Excessive debt may put the economy onto an unsustainable growth path that ends in tears. Repayment promises are broken, hopes and plans are dashed, and the economy tumbles into recession.

Before we go too much further, we need to acquire some basic financial tools – especially balance sheet analysis – to help judge whether financials/debt cycles could generate unwelcome shocks further down the road. So prepare yourself for more jargon – leverage, gearing, capital, liquidity.

Armed with our expanded toolkit we observe that business cycles (usually defined as variations in real GDP performance) are only part of the volatility that macro-economies are subject to on a short- and medium-term basis. Variations in asset prices (especially those of equities, bonds and property) need to be carefully watched. As bitter GFC experience proved, favourable real GDP/inflation performance can mislead the unwary. While politicians were lauding the abolition of the business cycle, the lesser-watched global financial cycle was already close to a Minsky meltdown that engulfed us all by 2008. The Covid-19 episode similarly carries more than just health threats, The disruptive influence on activity and corporate solvency could well add a financial trauma to the mix; a scenario that we all want to avoid.

A key instrument in the world of finance is, of course, money.  Money is certainly useful and commands a price. Indeed it is so useful that its price can be expressed in at least four ways. However, that discussion would require too much of a digression in class so our key focus will be on the interest rate price. Money itself rarely generates a return so interest rates can viewed as an opportunity cost: the return that is foregone by holding money rather than holding US Treasury bills or bonds (with their typically positive returns).

The principle sounds easy enough but then we unveil another key takeaway – there are many different types of interest rates. Nominal and real, spot and forward, natural and….well… unnatural. Moreover, where debt is involved, interest rates will vary according to the repayment period: payback in a few weeks’ time, 30 years? And then there is a critical debt question: how risky is the borrower? Understandably, the US Treasury can borrow at much lower rates than a company with a poor credit history. Finally, we need to embrace assets that do not have repayment promises attached (equity as opposed to debt).

New journeys, new challenges. Your Intermediate Macroeconomics voyage continues!

15 Oct 2020

The First Session (Continued)

Usually I don’t issue a blog for each half-session but, since the start of this semester has been punctuated by a holiday, I’ve made an exception!

Tomorrow ( Wednesday 9 Sep) at 9.00am London time we’ll pick up from where we left off – GDP data. Again, I cannot over-emphasise how important data gathering, analysis and interpretation are. The course is all about macro models. Good models need the best data we can muster; data are always imperfect but we should work hard to ensure that foundations are as solid as they can be. Without that, it’s just garbage in, garbage out.

So we shall start with a discussion on that US GDP exercise I left you with. Hopefully, you have used the opportunity to explore the joys of growth calculations, extracting numbers from FRED and brushing up on natural logs, exponentials, power terms, etc.

Unfortunately, getting and “cleaning” data are not the only obstacles to overcome before we get down to building our first model – the Solow growth template.

There are many other practical and conceptual hurdles concerning

  • Aggregation
  • Volatility (please have the chart below handy when we meet)
  • Revisions
  • Boundaries
  • Product quality
  • Happiness

Moreover, GDP is a handy single metric but it’s just a flow for a period of time. What about stocks and sustainability? These are massive issues for the 21st century brought into clear focus by pandemic and climate change challenges.

I look forward to seeing you all tomorrow and hope you had a relaxing holiday.

8 Sep 2020

The First Session

Stephen Hannah

9.00-10.15AM Wednesday 2nd September

Attendance register to be taken

Laptop/smartphones/calculators/spreadsheets/pen & paper will be necessary for most classes

Physical: Bedford Square Room G07

Zoom: the link has been provided to you on NYU Classes and in your syllabus, already circulated (please check your NYU emails and the NYU Classes Announcements for this course)

Pre-Meeting Prep

Step #1

Go to the course website and read the Welcome post

Each week I add a further blog post providing a gentle introduction to the topics to be covered for the relevant, upcoming session

You do not require a password to read this material

Step #2

Please browse the course syllabus 

This became available on NYU Classes yesterday but is also directly viewable on the course website at (check out the Miscellany tab on the course website)

To follow up this link you will need a password which has been provided to you on NYU Classes (check recent announcements)

The password will also grant you access to the other sections of the website (Schedule, Assessments, Contact Details, etc)

Step #3

Try to do some preliminary reading.

Briefly scan the first chapter of the recommended Jones textbook (preferably the 5th edition but the 4th edition will do) and/or look at the Bureau of Economic Analysis primer on GDP. Undoubtedly you will have come across the concepts in Principles but it’s good practice to review and refresh.

Risk Assessment

Since this course is blended, I must always wear a mask in Bedford Square – including the classroom. This may seem strange for those joining me on Zoom for the 9.00-10.15am slots (virtual office hours are different, of course). Please be assured. I do know that Covid does not spread over the web; it’s just that I need to respect the safety and wishes of those joining the class in person.

So far, since the first lockdown ended, the resurgence of UK Covid cases has been gentle and not too threatening. However, winter is coming, so we cannot rule out circumstances that restrict my (and your) ability to follow the proposed timetable. As such, the course has been structured to enable an immediate switch from blended to online-only. So, when you get round to exploring the Course Website, you will see lots of hyperlinks to online articles, pre-recorded videos, pdf learning materials, worked exercises, completed quizzes, etc. There’s a lot there, far too much for immediate consumption. Better to think of it as a store cupboard – a cornucopia of just-in-case goodies, not advisable to eat all at once!

If you have any questions or concerns, please email me as soon as possible. Again, the email link is available in NYU Classes, in the firewalled section of the website and in the syllabus already circulated to you.

31 Aug 2020