advanced topics in macroeconomic theory and policy

Department of Business Economics, Ramanujan College University of Delhi University of Delhi

Faculty Development Program

ADVANCED TOPICS IN MACROECONOMIC THEORY AND POLICY

06th March to 14th March 2020

The Department of Business Economics and Teaching Learning Centre (under

PMMMNMTT), Ramanujan College, University of Delhi organized a One Week

Faculty development program on “Advanced Topics in Macroeconomic Theory and

Policy” from 06th to 14th March, 2020. Around 31 participants (young research

scholars and Assistant Professors of colleges and universities) from different parts of

the country and across varied disciplines such as Economics, Commerce, Business and

Management participated in the workshop.

Day 1: 06th March, 2020 (Friday)

Inaugural Session

The Inaugural Session of the Faculty Development Program on ‘Advanced Topics in

Macroeconomic Theory and Policy’ was held on Friday, 6th March, 2020 from 9.30 a.m.

to 10 a.m. at Room No. 115, Arts Faculty Building, University of Delhi South Campus,

presided over by Prof. Vijay Kumar Kaul (Head, Department of Business Economics and

Dean, Faculty of Applied Social Sciences and Humanities, University of Delhi). Dr. S.P.

Aggarwal (Director, TLC and Principal, Ramanujan College), Professor Mausumi Das

(Resource Person, Institute of Economic Growth), Dr. Vibhash Kumar (Coordinator,

TLC, Ramanujan College) and Dr. Ananya Ghosh Dastidar (Convenor) also shared the

dais. Prof. Kaul’s welcome addressed the tone by emphasizing the importance of

learning advanced macroeconomic tools and techniques, both for academics as well as

policy practitioners, at the current conjuncture. He appreciated the efforts made by the

organizers, the infrastructure at South Campus that facilitated the program as well as

the contribution of the participants that was fundamental for funding the FDP.


Thereafter, in his special address Dr. S.P. Aggarwal appreciated the MHRD initiative,

through the PMMMNMTT, for improving the teaching learning process via such FDPs.

The TLC, Ramanujan College had organized nearly 40 FDPs till date, but the current one

was unique as it focused on advanced research in a niche area in Economics. Given

greater autonomy, higher education institutions could design more such novel

initiatives for improving teachers’ knowledge base and quality of teaching. Finally, the

Convenor Dr. Ananya Ghosh Dastidar, thanked the Dean, FASSH, her department

colleagues and Director TLC, Ramanujan College and his supporting staff for making the

FDP possible. In particular, she thanked the participants, many of whom had travelled

long distances to participate in the FDP, despite the public health threat due to spread of

the Corona Virus infection. She reported that throughout the program, adequate

precautionary measures (e.g., use of hand sanitizers, paper napkins etc.) were being

adopted to address health concerns in view of this virus threat.


Session I & II: Introduction to Dynamic Optimization: Mausumi Das

Setting the framework of the workshop, Prof. Mausumi Das drew attention to the

structural shift in macroeconomics since eighties with the rise of the DSGE models

as the main workhorse model. Ever since it has become important in

macroeconomic modelling, both at the theoretical level as well as at the policy

level. She traced the genesis of this shift to the classic paper by Robert Lucas.

Through his critique, Lucas drew attention towards incorporating rational

expectations and forward looking behaviour of the optimising agents. This raised

questions on the models based on a priori values assigned to parameters, like in

the IS LM models. Lucas argued that it was naive to predict the effects of change in

economic policy on the basis of the historically observable data, and, made a case


that the rational responses of the individuals both of the forward looking nature as

well as based on rational expectations ought to be incorporated.

Even when the New Keynesian DSGE models differ from the Real Business Cycle

models, in the sense that the former incorporated issues relating to the stickiness

of wages and prices and imperfections in market structures, they are both

characterised by representative agent optimizing on an infinite horizon,

incorporating forward looking behaviour based on and rational expectations.

Given the importance of the understanding the analytics of dynamic optimization

towards appreciating these models of both RBC as well as NKE variety, Prof Das

further traced the transition from the static optimization using Lagrange to

dynamic optimization, introducing the class to the basic algebra as well as logic

behind Euler equation as well as transversality condition


Session III & IV: Asset Pricing Models & Selected topics in International Finance:

Saumya Datta

The session began with a brief introduction to microeconomic models for pricing

financial assets such as Capital Asset Pricing Model, Arbitrage Theory, Black-Sholes

Merton Pricing Formula (for pricing of derivatives) and basic financial concepts such as

the Efficient Market hypothesisas well as the role of capital and financial markets.

Participants were then introduced to the Arrow-Debreu Model starting with crucial

assumptions, followed by its mathematical framework. Risk premium, certainty

equivalent, complete & incomplete markets, time-zero trading and the concept of an

Arrow-Debreu security are some of the topics that were covered. The session ended

with a discussion on the 2008 financial crisis highlighting the role of inter-bank lending

and the introduction of the derivative markets.


Day 2: 07th March, 2020 (Saturday)

Session I & II: Modern Business Cycle Theory: Mausumi Das

In these two sessions, the speaker discussed the dynamic programming technique

which is used to solve an optimization problem defined over infinite horizon. The

speaker started with the basic infinite horizon household optimization framework with

a representative agent - which is the primary workhorse of the modern DSGE modelling.

She discussed the consumption-savings choices of a representative household over

infinite horizon when markets are perfect. Having discussed the household problem, the

Planner’s problem was analysed. It is well-known in the literature that when agents are

rational and have complete information, the representative household’s choice problem

under perfect market (with no externalities) coincides with the planner’s problem (First

Welfare Theorem).

The speaker also discussed the method of solving the difference equations with various

types of boundary conditions and then used these solutions to characterise the dynamic

properties of the economy. She then extended the perfect market framework to

incorporate: labour-leisure choice on part of the household. Next she broadened the

scope of the model by introducing heterogeneity across households by assuming that

household differ in terms of their initial asset holding (asset heterogeneity but

homogenous preferences).


Session IV: States of Growth of Indian States: Sabysachi Kar

The focus of this session was to understand the convergence/ divergence in growth

across Indian States. A three tier approach of (i) Identifying clubs (showing

convergence) across regions in India, (ii) identifying growth breaks and (iii) studying

the impact of growth breaks on club convergence was discussed. A stochastic kennel

graph was studied to understand if there has been any club convergence over the years

in India. This was further explored by using a technique given by Phillip and Sul (2007)

to identify growth clubs, highlighting, beta and sigma convergence. Convergence is

defined in terms of relative transition coefficient and semi parametric estimation was

adopted. Bai and Perron’s estimation strategy to identify growth breaks was also

discussed. Finally, the last part of the session focussed upon assessing the impact of the

identified growth breaks on the convergence of clubs using a regression framework.


Day 3: 11th March, 2020(Wednesday)

Session I & II: Technology and Endogenous Growth Models: Meeta K Mehra

These two sessions started with brief discussion of Solow model of growth theory and

Augmented Solow model which are models of endogenous growth with constant

returns to scale. The sessions then focussed on three endogenous growth models, (i) AK

model – Convex Endogenous Growth Model, given by Rebelo, 1990 (ii) Model of public

infrastructure –Fiscal expenditure of government given by Barro, 1990 (iii) Learning by

doing models – Increasing Rates of Return given by Romer 1986. The three models were

discussed in details; solving for the competitive equilibrium and commandeconomy

(planner’s equilibrium) using the dynamic optimization techniques. The steady state

equilibrium paths were discussed. The assumptions and different implications of the

three models were analysed. The session ended with discussing the relationship

between increasing returns and endogenous growth. This session was extended further


on the last day of the workshop (Session III, Day 5, 13th March, 2020(Friday), with a

discussion on the Lucas Model of Human Capital Accumulation stressing upon the role

of externalities. This was followed by discussing the Roemer Model which introduced a

separate R&D Sector to explain the endogenous framework.

Session III & IV: New Keynesian Models: Theory and Simulations Using Dynare:

Jyotirmoy Bhattacharya

The session focussed on discussing the New Keynesian Models, which are extensions of

Real Business Cycle (RBC) Models. Real Business cycles were already dealt in detail in

the first two days of the workshop. These models incorporated money and interest in

the RBC models and introduced some rigidities in the prices and wages in the economy.

As there is no point in controlling money supply, the main objective of the monetary

policy is to fix the nominal interest rate. The model assumedrational expectations in the

agents’ behaviour and was discussed and derived in the session. The important take

away from the model is that policy regimes matter in the economic decisions. As long as


people choose and adopt a forecast (based on Central Bank policy rule), the policy

regimes play an important role in determining growth in the economies.

The basic introduction to the software Dynare used for the empirical exercise was also

covered. The practical application of the model and simulation exercise was

demonstrated along with a brief discussion on interpreting the empirical results. This

gave a good exposure to the participants as most of them were working on this software

for the first time.

Day 4: 12th March, 2020(Thursday)

Session I & II: An Introduction to Demand Side Growth Models –I: Subrata Guha

Prof Subrata Guha drew the attention of the participants to the literature on

demand-side growth theories. Contrasting the demand constrained models from

the umpteen number of supply-constrained models, he drew attention to the

differences in the approaches of the neo-Keynesians, from the neo-Kaleckians.

Whereas the pricing under the neo-Kaleckian framework was based on mark-up,

that of the neo-Keynesian models were based on competitive markets. The degree


of monopoly and collective wage bargaining plays an important role in the

determination of pricing under the neo Kaleckian framework.

Whereas in the neo-Kaleckian framework, in the short run, a higher rate of

accumulation leads to higher capacity utilization, which further enhances profit

rate, in the neo-Keynesian mechanism, higher rate of accumulation, results in

higher markup, resulting in a higher profit rate. (with the capacity utilization ‘z’

remaining the same) . In fact, the differences follows from the assumptions related

to market structures in the two schools. He further compared and contrasted the

dynamic impact of increase in savings (paradox of thrift) under the neo-Kaleckian

as against the neo-Keynesian school. Whereas in the neo-Keynesian setup, price

adjustment was the route, under the neo-Kaleckian framework, quantity

adjustment through changes in capacity utilization occurred.

Prof. Guha further drew attention to the article by Bhaduri and Marglin, which

illustrates multiple possibilities under capitalism. The possibility of co-operative

capitalism (wage-led growth) wherein the profits increase with an increasing share

of wages was highlighted. He concluded his lecture by drawing attention to the

studies of a neo-Harrodian genre which characterise growth in capitalist

economies within the narrow corridors of instability, as against the steady state

perspectives of the other approaches.

Session III and IV: Studying Macroeconomic relationships using VAR: Lokendra

Kumawat

This session focussed on the empirical techniques used to analyse dynamic

relationships in macroeconomic variables. The distributed lag models were discussed.

However, these models are restrictive in nature and do not allow for feedback effects.

The macroeconomic variables are generally endogenous and hence feedback effects

cannot be ignored. The two ways to take into account this endogeneity in variables were

discussed. The first is the use of Simultaneous Equation Models. They suffer from

limitations of dichotomy of endogenous and exogenous variables in the model and

restrictions for identifications of the model. The session then dealt in detailed

discussion of Vector Auto Regression (which overcomes limitations of the previous

models). The specification of VAR was discussed which included selection of variables,


selection of lags, choice of deterministic components, estimation of the parameters and

checking for adequacy of the parameters. The uses of VAR for forecasting, checking for

granger causality and innovation accounting were elaborated along with the

understanding of impulse response functions. At the last, the structural decomposition

of VAR model was also covered.

The session also demonstrated the practical application of VAR model. A two series

model of money supply and index of industrial production was taken to provide first-

hand experience of running VAR model to the participants, to analyse the results and

check for different diagnostics tests for model accuracy.


Day 5: 13th March, 2020(Friday)

Session I & II: Empirical Issues in Macroeconomic Models: Rudrani Bhattacharya

The sessions focussed on providing detailed discussion on the empirical research in

macroeconomics and the steps followed for carrying out time series techniques for

empirical analysis. The focus was on the estimation of monetary policy transmission for

the Indian economy. The closed economy model was assumed. The dynamic IS and

Inflation Augmented Phillips Curve were discussed along with Taylor’s Rule (monetary

policy response of central bank) to close the above two equations model. VAR technique

is adopted for such model due to endogeneityof variables. The steps followed to

estimate the output gap were elaborated, which included (i) De-seasonalize the

variables. The method adopted depends on the type of seasonality. For fixed

seasonality, dummy variable approach is adopted. For stochastic seasonality,

autoregressive process is adopted. In this respect, Seasonal ARIMA (Auto Regressive

Integrated Moving Average) approach was elaborated. (ii) De-trend the variable (iii)

Unit root test. The different tests for unit root and conditions to choose a particular test

result were discussed. Lastly, the session focussed on the approachesand data used to

find the factors affecting food inflation. Both demand side factors and supply side is

captured to estimate the demand – supply gap for all goods to analyse the policies to

stabilise food inflation in the economy.


Session IV: Should Central Banks Respond to Food Inflation? : Chetan Ghate

The session focussed on the analysing two issues for the Indian economy –Should

Central Bank target food inflation? And whether it would create consumption inequality

in the economy? The session looked at the model of two sectors comprising of

Agriculture and Manufacturing. The model also included heterogeneity of agents by

including two agents –Rich and Poor. The model featured as explicit procurement and

redistributive motive of the government. The government taxes the rich agent, procures

grain and redistributea fraction of it to the poor. Household optimization over

consumption and disutility over labour was derived and aggregate agricultural

consumption was estimated. Two shocks were then introduced in the model:

Procurement shock and Redistribution Shock, both following AR (1) process. The

equilibrium was derived using Dynamic IS curve, Inflation Augmented Phillips curve

and Taylor’s rule.


The model then tried to simulate the effects of two shocks: (i) agricultural productivity

shocks and concluded that productivity increase leads to fall in price of agricultural

goods and worsening of terms of trade. Real wage increases for both sectors but

employment effects vary. Employment in agricultural sector falls and in manufacturing

sector increases, emphasizing the disparity of the two sectors. (ii) Single period

procurement and redistribution shock.Here, price of agricultural good increases and

terms of trade improves. Real wage also increases but the impact on employment differs

from above (as productivity has not increased). Employment in agriculture sector

increases and in manufacturing sector goes down. This leads to poor agents getting

better off and lessening of inequality in the economy. Prof. Ghate’s discussion was based

on work in progress and working paper version of his paper would be officially

available around June 2020.

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advanced topics in macroeconomic theory and policy

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