Tuesdays 11AM to 1PM -- Fall Term -- NEW ROOM: LA 248
Prof. J. E. Floyd -- Office: Rm 264, Max Gluskin House,
150 St. George St.,
Phone: 416-978-4349
E-mail: floyd@chass.utoronto.ca
Web-Page: http://www.economics.utoronto.ca/floyd
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This is a 400-level course for upper-level undergraduates and graduate students. Undergraduates should contact me before enrolling. Those who have more than one C and no A's in the prerequisite courses and plan on working no harder here than they have in the past can very easily fail this course! Undergraduates who have the ability and work habits to eventually do graduate work themselves should not find it difficult to compete with the graduate students in this course---indeed, the top undergraduates typically get high A's. But this is not an appropriate course for students who are anxious to get on to other things and whose overriding objective is simply to obtain a mere 50% grade to get the necessary credit to graduate.
Prerequisites for this course include a decent background in intermediate microeconomics and macroeconomics and elementary statistics. Some elementary calculus and matrix algebra will be used from time to time. Those who have excellent backgrounds in mathematics and statistics can get by with a weaker background in economics because ease with technique will permit more time to be spent on the basics of economics. Upper-level undergraduates and M.A. students, and potential Ph.D. students as well, will find this course useful in developing skills that will be useful for entry-level positions in the financial services industry.
Study question assignments have been prepared and can be downloaded from this web-site. You are expected to use the study questions and exercises to stimulate your thinking about the issues dealt with in the readings. In some of these exercises you will "get your feet wet" in real data.
There will be twelve two-hour classroom sessions, two of which will be used for tests. In those two cases, students will write the test in the first hour and the answers will be taken up in the second hour. Students and can see me in my office (I am usually there most afternoons) to discuss their answers to the study question/exercise assignments, which they will not hand in for grading. I am also there to provide any other help students might feel they need.
Because the background and initial preparation of students entering this course will be diverse, some elementary computer-assisted study modules will be assigned during the term. These will bring everyone up to speed on some of the basics which will therefore not have to be reviewed in class. Past experience indicates that students who have done previous work in macroeconomics at an advanced level, or who have taken a third year international macroeconomics course, do not take these modules seriously, figuring that they already know the material. This is a big mistake! My experience is that even quite advanced students do not really understand the material they have taken in previous courses. One reason for this is that macroeconomics courses differ in organization and content so that students in this class will have specific views of what macroeconomics is about that differ both from student to student and from the approach taken here. As a result students are typically unable to deal with questions posed in different ways than that to which they are accustomed. A second reason is that students' primary objective is often to get an appropriate grade in a course rather than learn the material, so they tend to learn just what is necessary to be able to put the "right things" down on the final exam. Figuring out what might be asked on the final exam and how to phrase an answer to it is quite different than learning the fundamentals of a subject. A third reason is that international macroeconomics is a difficult subject and it takes several courses before students begin to understand the fundamentals. The fundamentals are the sine qua non for understanding what is going on in this field. Every model has to be based on and relate properly to these fundamentals if it is to be of any use---students who understand models but not the fundamentals on which they are based have no useful knowledge of macroeconomics. On the other hand, students who understand the fundamentals and have a good mathematics background can easily construct and evaluate models to deal with specific questions as they arise. The basic objective here is to teach you the fundamentals. These are completely contained in the modules. The rest of the course is necessary to get you to the point where you have a sophisticated understanding of the material in those modules and more fully understand the theoretical foundations of that material. You should therefore take the computer modules very seriously, because you will not get a decent grade in this course without understanding the material they contain.
The course material to be covered is divided into four sections or units. All reading material assigned is compulsory except where noted---the main exception will be background material covering statistical techniques where your existing skills may be sufficient to make review redundant.
All the published materials required in this course are on on reserve in Robarts Library. The computer-assisted study modules can be worked through by just clicking on the links to the relevant html files below.
There will be two major tests and a final exam. The first test will cover the computer-assisted study modules assigned plus the material covered in class up until it given, which will be about 5 weeks into the course. The second term test will cover the computer module and class material up to the time it is given, 9 or 10 weeks into the course. The final exam will, of course, cover the entire course including those parts that were not covered in the second term test. The term tests will each count for 20 percent of the final grade. In-class participation will count for 10 percent of the final grade and the final exam will count for the remaining 50 percent.
I have constructed a set of Occasionally Asked Questions together with rather complete answers. You may find these useful.
Students who need to improve their background in the basics of mathematics and statistics should download and work through the material I have prepared for that purpose --- Mathematics Review for Economics Students and Basic Statistics Review for Economics Students. Students who find these reviews insufficient can refer to appropriate parts of the documents that were used in constructing those review materials. A good reference from which students can brush up on their basic mathematics skills is Alpha C. Chiang, Fundamental Methods of Mathematical Economics, McGraw Hill, 1984, which is on course reserve in the UofT library. For the basics of algebra, read pp. 7-32. Equilibrium analysis and matrix algebra are covered on pp. 35-87. Discussion of derivatives and slopes of functions can be found on pp. 128-178 and pp. 254-262. Exponential and logarithmic functions are covered on pp. 268-306 and integrals are discussed on pp. 437-454. A more recent version of the book, the 4th edition, authored by Alpha Chiang along with Kevin Wainwright in 2005, is available for reading in the 2nd. floor library in the Rotman School of Management. The best procedure for using this book is to utilize the index to find the main topics and then read the parts that you need to learn. Also, a nice review of matrix algebra is contained in Appendix A of Jack Johnston and John DiNardo, Econometric Methods, McGraw-Hill, 1997, pp. 455-67 (to the end of section A.2.7). This book is also on reserve in the UofT Library.
To acquire further statistical background students should read, as their circumstances dictate, G. S. Maddala, Introduction to Econometrics, Chapters 2 and 3, pp 9-51. Alternatively, you can read James H. Stock and Mark W. Watson, Introduction to Econometrics, Addison Wesley, 2003, pp. 3-195. The Maddala and Stock and Watson books are on reserve in the UofT Library. If you find this material too difficult you can work through the notes I have prepared for my basic statistics course. Also, to learn about heteroskedasticity- and autocorrelation-consistent standard error estimation you should read pp. 607-617 of the Stock and Watson Book. A matrix-algebra-focussed treatment of multiple regression is contained in Johnston and DiNardo book noted above, Chapter 3, Section 3.1, pp. 69-76 and Section 3.4, pp. 86-98 (you can skip Sub-section 3.4.4). Appendix B, pp. 485-90 (to the end of section B.4), contains a further presentation of statistics concepts.
Students are encouraged to empirically investigate on their own some of the analysis presented in the course. For this purpose they can obtain relevant data from this web-site which can be analysed using the freely-available statistics softward program Gretl or even MS-Excel, a sufficent clone of which, called Gnumeric, is also freely available off the web. For the basics of working with Gretl and getting started doing statistical programming in free programs XLispStat and R, a free clone of the statistical program S, you can consult some materials I have prepared for that purpose in Statistical Analysis Using XLispStat, R and Gretl: A Beginning. And for day-to-day work in Gretl I have written a short Gretl Mini-Manual.
Students should also have a decent background in basic microeconomics to get the full benefit of working through this course. Three computer-assisted-learning modules are available for this purpose: Supply and Demand, Rents and Externalities and Additional Topics. Students should work through them as necessary. Background references are listed at the end of each topic.
The analytical framework used for most of this course is single-period focused---that is, it examines aggregate equilibrium of the economy in a single period or a succession of single periods, most frequently with reference to deviations of output around the full-employment level. But consumption, investment and government budget decisions are based on the maximization of utility not just in the current period but simultaneously in the current and all future periods.
Ideally, therefore, to completely understand the current state of the economy we should solve simultaneously for equilibrium not only in the current period but in all future periods as well, with the equilibria in future periods representing the expected and planned future outcomes as viewed from the present. Decisions in the present are thus interconnected with all future decisions and cannot be analyzed without understanding agents' inter-temporal utility functions and expected future constraints.
The problem with inter-temporal models is that they become extremely complicated when we try to focus on more than one or two simple relationships at a time and as a result do not provide a good overview of the broad picture. Single-period aggregative models, on the other hand, can provide an excellent framework to think about the important day-to-day macroeconomic problems. Indeed, they form the basis for virtually all the current analysis and forecasting efforts of practitioners in the field.
But single-period aggregative models can do this only if they take all of the important implications of inter-temporal maximizing models implicitly into consideration. This is why the computer-assisted study module on fiscal policy, for example, considers the effects of taxes on permanent income and on inter-generational asset accumulation. It is also why the fiscal policy analysis developed there could say far less about the effects of fiscal policy than older Keynesian IS-LM models claim to be able to say. In fact, I could not have written those computer modules and most of the other material presented in this course without prior knowledge of the implications of inter-temporal maximizing models.
Accordingly, in this first section of the course we must establish appropriate inter-temporal foundations for the models that will be later developed. The task is not to develop a big inter-temporal maximizing model of a multi-country world---such a model would be too complicated to shed any light on the issues we want to examine. On the contrary, what we must do is make sure that the features of the single period models we will be using take proper account of the underlying process of inter-temporal maximization that forms the basis for the individual decisions that ultimately combine to create the observed magnitudes of the economic aggregates on which our models will focus.
The task here essentially involves understanding the process by which the full-employment level of output gets established at each point in time and, since saving and investment are occurring, the underlying growth rates of those full-employment magnitudes. This can be accomplished by working through the material in a few chapters of my book, J. E. Floyd, Interest Rates, Exchange Rates and World Monetary Policy, Springer-Verlag, 2010, which will here-after be referred to simply by its title. I have decided against having my students buy this book as a textbook. Accordingly, I have placed four copies on reserve in Robarts Library. Two of those copies can be taken out on loan for three hours, and two can be taken on loan for two days. Also, the book is available in e-book form in Robarts Library and can be read by everyone directly off the web.
To begin with, you should work through the first computer-assisted learning module, The Dimensions of Economic Activity . The material it contains is very elementary but it provides a bit of focus. Then you should work through the second module Interest Rates and Asset Values and the third, Money and Inflation For students with a good economics background this material should be an easy review as a prelude to working through material in my book. Two additional computer study modules, Interest Rates and Growth and Unemployment are available for interested students but not assigned because it is simply assumed in this course that wages and prices are slow to adjust but do so eventually, and the details of the growth process that you need to know are covered in the assigned readings from my book.
The assigned reading for this section of the course is Chapters 2, 3, and 4 consisting of pages 11 through 57 of Interest Rates, Exchange Rates and World Monetary Policy. In doing this reading, students should focus on the questions in Assignment Number 1, and on the material in Advanced Topic 1: Intertemporal Foundations I and Advanced Topic 2: Intertemporal Foundations II which outline the issues and material from the book that will be discussed in class. The material in the first of these two advanced topics draws on the R script dliqcalc.R and the material in the second refers to the two scripts GGAAssg.R and GGAA.R, the first of which generates output that is in the Exel file GGAAssg.xls. These, are worth working through to develop the fullest understanding of the material in the two Advanced Topics.
Another very useful read is the first 39 pages of the book Foundations of International Macroeconomics by Maurice Obstfeld and Kenneth Rogoff, published by MIT Press. The material presented provides a solid basis for arguments pursued thus far and in the rest of this course. Reading this material is suggested for those who are interested, but it is not required reading. Those who choose to work through it will find the solutions for the problems in Obstfeld and Rogoff available in .pdf form from Rogoff's home page at Harvard. Also Bridget O'Shaughnessy and I have made some notes (postscript 195k) to help those who want to read the assigned section of Obstfeld and Rogoff and do problems 1 through 4c at the end of Chapter 1.
Before proceeding further, you should work through the next three assigned computer-assisted study modules Asset Markets, The Foreign Exchange Market and Small Open Economy Equilibrium I: The Balance of Payments and the Exchange Rate,
Next you should work through the presentation file Advanced Topic 3: Real and Monetary Shocks and Balance of Payments Equilibrium which pulls together the general equilibrium nature of the relationship between savings and investment and the current account balance discussed in the above computer-assisted study module The Balance of Payments and the Exchange Rate. It also makes a fundamental point about the nature of balance of payments equilibrium which will be discussed in a more elementary way in computer-assisted study module Monetary Policy Under Fixed Exchange Rates assigned below---if you have difficulty understanding that section of the above Advanced Topic presentation, simply set it aside and return to it later after you have worked through the Module.
At this point it will be worthwhile for you to read
Next you should print out the assignment for this section of the course, Assignment Number 2. Keep an eye on the assignment questions as well as the material in the presentation Advanced Topic 4: Exchange Rate Determination I as you work through Chapters 7 and 8, pages 99 through 130, of Interest Rates, Exchange Rates and World Monetary Policy, using them as a guide to what you should be learning. The goal should be to understand the material in the Advanced Topic presentation. You can access the data referred to and statistical input files used and outputs produced if you wish to.
It will become apparent as you work through the above material that some knowledge of elementary time-series analysis will be necessary. If you feel you need it, you should read
You will also find it useful to read
The next presentation, Advanced Topic 6: Exchange Rate Determination III, works through material in Chapter 10, pages 157 through 208 of Interest Rates, Exchange Rates and World Monetary Policy that investigates the effects of various real factors determining the levels of countries' real exchange rates along with an explanation of the forces determining domestic minus foreign interest rate differentials, which tend to be correlated with real exchange rates. The data for Canada vs. the United States, along with the relevant statistical analysis, is contained in the Gretl session file causrex.gretl. The data, program and output files for the analysis of the other countries vs. the United States are available at the links above.
The final Advanced Topic presentation for this section of the course is Advanced Topic 7: Exchange Rate Determination IV which covers Chapters 11 and 12, pages 209 through 268 of Interest Rates, Exchange Rates and World Monetary Policy. The first chapter adds alternative measures of unanticipated money shocks to the regressions above that explain real exchange rate movements and to the regressions that explain interest rate differentials. The second chapter develops and applies a Blanchard-Quah VAR analysis to the movements of real and nominal exchange rates. Again the relevant statistical application, output and data files can be obtained via. the links above. The nature of Blanchard-Quah analysis is explained in pages referred to in Chapter 12.
For bed-time reading (not required if you have something better to do at bed time) you might read
Christopher J. Neely, "Technical Analysis in the Foreign Exchange Market: A Layman's Guide" Federal Reserve Bank of St. Louis Review, Vol. 79, No. 5, September/October, 1997, pp.23-38.
Work your way carefully through the computer-assisted learning module, Small Open Economy Equilibrium II: Monetary Policy Under Flexible Exchange Rates.
Now work through the module Small Open Economy Equilibrium III: Monetary Policy Under Fixed Exchange Rates.
Before proceeding further you should print out Assignment Number 3a, and Assignment Number 3b, so that you can refer to the assignment questions and exercises as you read the material that follows.
Now work your way through Advanced Topic 8: A Basic Two-Country Model which consolidates and extends the material already presented in this Section. As background you can read Chapter 13 of Interest Rates, Exchange Rates and World Monetary Policy, consisting of pages 269 through 288. For a fuller and more complete discussion of two-country situations where both countries are big and one of those big countries is really an aggregate of many small countries, it is essential that you work through the computer-assisted learning module Big Open Economy Equilibrium. Since fiscal policy is discussed in that module, you must first work through the module entitled Small Open Economy Equilibrium IV: Fiscal Policy. The computer-assisted learning module Small Open Economy Equilibrium V: Additional Policy Issues should also be worked through to get a full understanding of all the issues involved.
To broaden and deepen your understanding of the gold standard you can work your way through
To start, print out the assignment, Assignment Number 4, to use for guidence as you work through the readings. You should then work carefully through the module Conducting Monetary Policy. Next, work through Advanced Topic 9: Conducting Monetary Policy, and then work through the working paper Canadian Monetary Policy and Real and Nominal Exchange Rates.
For an interesting policy discussion applying the principles you have learned thus far, you should read
We now shift our focus to the study of currency unions. To acquire relevant background knowledge relating to the establishment of the Euro Area, you can read
For an analysis of the recent controversy about whether Canada should adopt the U.S. dollar as its currency, go through
For an an excellent summary analysis of the case for flexible vs. fixed exchange rates by Alan Stockman.
For an excellent practical discussion of monetary policy in Canada, you might want to read