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Learning and Dynamic Contracts in Macro: The Case of the EU (ECO-AD-CONINMAC)

ECO-AD-CONINMAC

Purpose

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Description

As the title says, this half-credit course focuses in two broad topics in macro theory, with a European applied and policy perspective. It’s self-contained but assumes knowledge of dynamic programming and dynamic general equilibrium macro. After a short introduction on the EU background, we go back to the rational expectations revolution, with a brief introduction to ‘learning in macro’ and Self Confirming Equilibrium. Then, we briefly through Recursive Contracts theory to set the basis for the for the last themes of the course: the Fiscal Theory of the Price Level, Sovereign Debt Crises and on Making the Debt Safe with
a Financial Stability Fund. For students taking the course for credit, they will need to ‘Deconstruct’ one or two related papers on one of the topics covered in – or related to -- the course. They will be graded based on the presentation of the ‘deconstruction’ 85%, the and class participation 15%.

Topics
1. Brief introduction to the course. From economic history, theory, policy and back: the case of the European Union and euro area.
The EU it is a good historical experiment to study the interaction of the development of economic theory with evidence and policy and institutional design. The course will deal mostly on the theory but will have this in mind until the end.

Bernanke, Ben. 2022. 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19, W.W. Norton.

Cochrane, John H., L. Garicano and K. Masuch. 2024. Reforming the Euro: Lessons From Four Crises. (forthcoming book). (*) at least 1. Introduction and overview.

Friedman, Milton. 1960. A program for monetary stability, Fordham University Press. Lorenzoni, Guido and Iván Werning. 2023. “Inflation is Conflict”, M.I.T.

(*) Sargent, Thomas J. 2008. “Evolution and Intelligent Design,” American Economic Review, 98 (1): 5 -37.

1 For example, from the long reading list but other related papers are also possible. In any case, no later than November 28 you should let me know which paper(s) you want to decompose to have your choice approved. In case of duplications, the first to come gets the paper. 15 – 20 minutes presentations will take
place on January 2025.

2. Self-Confirming vs Self-Fulfilling Equilibria. With a brief introduction to macro-learning models.
All dynamic macro models need to specify how agents form their expectations. The most common: subjective beliefs = objective beliefs; as in rational expectations equilibria (REE) – in particular, with possible multiple self-fulfilling equilibria (SFE). Macro-learning models
address Nash’s question -- how a Nash equilibrium (in macro, a REE) can be reached? -- or better, which REE is ‘learnable’. Importantly, they can help to better explain macro-financial data. I will refer to SFE multiplicity, but focus on subjective-beliefs equilibria -- e.g. Self-
Confirming Equilibria (SFE) -- and how they can help to model crises and ‘missing opportunities’. To start, I will provide a brief self-contained introduction to macro-learning models.

Adam, Klaus, Albert Marcet and Juan Pablo Nicolini. 2016. “Stock Market Volatility and learning,” Journal of Finance, 71(1), 33-82.
Adam, Klaus and Sebastian Merkel, 2019. “Stock Price Cycles and Business Cycles,” University of Oxford.

Aguiar, Mark, Satyajit Chaterjee, Harold L. Cole and Zahary Stanebye, 2021. “Self-Fulfilling Debt Crises, Revisited,” University of Pennsylvania, Pier Working Paper 20-003.

Ayres, João, Gaston Navarro, Juan Pablo Nicolini and Pedro Teles, 2018. “Sovereign Default: The Role of Expectations,” Journal of Economic Theory, 175, 803 – 812.

Ayres, João, Gaston Navarro, Juan Pablo Nicolini and Pedro Teles, 2021. “Self-Fulfilling Debt Crises with Long Stagnations,” Federal Reserve Bank of Minneapolis.

Baley, Isaac and Laura Veldkamp, 2023. “Bayesian Learning”, Chapter 23 of Handbook of Economic Expectations, Elsevier. Battigalli, Pierpaolo, Simone Cerreia-Vioglio, Fabio Maccheroni, Massimo Marinacci and Thomas J. Sargent, 2022. “A framework for the analysis of self-confirming policies”, Theory and Decision, 92(3):1-58

Cole, Harold L. and Timothy J. Kehoe, “Self-Fulfilling Debt Crises,” 2000. Review of Economic
Studies, 67 (1), 91–116.

(*) Evans, George W. and Seppo Honkapohja. 2001. Learning and Expectations in Macroeconomics. Princeton University Press. Chs. 1 & 2.
Fudenberg, Drew and David K. Levine, 2009. “Self-confirming equilibrium and the Lucas’ critique.” Journal of Economic Theory 144, 2354 - 2371.

(*) Gaballo, Gaetano, and Ramon Marimon. 2021. “Breaking the Spell with Credit-Easing: Self-Confirming Credit Crises in Competitive Search Economies,” Journal of Monetary Economics, 119, April.

Gertler, Mark and Nobu Kiyotaki, 2011. "Financial Intermediation and Credit Policy in Business Cycle Analysis," in Handbook of Monetary Economics, Vol. 3A.
Gertler, Mark, Nobu Kiyotaki and Andrea Prestipino, 2020. "A Macroeconomic Model with Financial Panics," Review of Economic Studies, 87(1) 240-288.

3 Hansen, Lars Peter. 2014. “Nobel Lecture: Uncertainty Outside and Inside Economic Models,” Journal of Political Economy, 122 (5): 945-987.
(*) Sargent, Thomas J. 1999. The Conquest of American Inflation. Princeton University Press. Ch. 3 - 7.

Woodford, Michael. 2013. “Macroeconomic Analysis without the Rational Expectations Hypothesis,” Annual Review of Economics 5: 303-346.

3. An introduction to Recursive Contracts to solve models with forwardlooking constraints or promises.
A wide range of dynamic macro models entail maximization problems with forwardlooking constraints (e.g. incentive, enforcement, participation or Euler-equation constraints). Similarly, Planner’s problems with recursive preferences entail promises (self-imposed constraints). I will provide a brief self-contained introduction to Recursive Contracts – as solutions to recursive saddle-point problems.

(*) Chien, Yili, Harold Cole and Hanno Lustig, 2016. “Implications of Heterogeneity in
Preferences, Beliefs and Asset Trading Technologies for the Macroeconomy,” Review of
Economic Dynamics (2016) 20, 215-239.

Cooley, Thomas, Ramon Marimon and Vincenzo Quadrini, 2004. “Aggregate Consequences of Limited Contract Enforceability,” Journal of Political Economy, 112, 4, 817-847.

Cooley, Thomas, Ramon Marimon and Vincenzo Quadrini, 2020. “Commitment in Organisations and the Competition for Talent”, The Review of Economic Studies, 87 (5), 2165–2204.

Grochulski, Borys and Yuzhe Zhang, 2017. “Market-based incentives,” International Economic Review, 58(2), 331-382.

(*) Marcet, Albert and Ramon Marimon, 2019. “Recursive Contracts,” Econometrica, 87(5), 1589 – 1631 Marimon, Ramon and Jan Werner, 2021, “The Envelope Theorem, Euler and Bellman Equations, without Differentiability”, Journal of Economic Theory, 196.

Thomas, Jonathan and Tim Worrall, 1994, “Foreign Direct Investment and the Risk of Expropriation,” TheReview of Economic Studies, 61 (1), 81-108

4. Fiscal Theory of the Price Level, the value of debt and sovereign debt crises
I introduce and use The Fiscal Theory of the Price Level to study ‘the value of debt’, its evolution and the Treasury – Central Bank interactions. Then I move to sovereign debt models.

Aguiar, Manuel and Manuel Amador, 2014. “Sovereign Debt,” in Handbook of International Economics, Vol. 4, pp. 647 - 687. North Holland. Aguiar, Mark and Manuel Amador, 2019. “Self-fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models,” Princeton Universiy.
4 Aguiar, Manuel and Harold Cole, 2016. “Quantitative Models of Sovereign Debt Crises,” in Handbook of Macroeconomics, Vol. 4.

Angeletos, George-Marios, Fabrice Collard and Harris Dellas, 2020. “Public Debt as Private Liquidity,” CEPR Discussion Paper 15488.
(*) Arellano, Cristina, 2008. “Default Risk and Income Fluctuations in Emerging Markets,”
American Economic Review, 98(3), 690 - 712.
Ayres, João, Gaston Navarro, Juan Pablo Nicolini and Pedro Teles, 2018. “Sovereign Default: The Role of Expectations,” Journal of Economic Theory, 175, 803 – 812.

Calvo, Guillermo, 1988. “Servicing the Public Debt: The Role of Expectations,” American Economic Review, 78, 647 - 661.
(*) Cochrane, John H. 2019. “The Value of Government Debt,” NBER Working Paper
26090.

(*) Cochrane, John H. 2023, The Fiscal Theory of the Price Level, Princeton University Press, forthcoming. Chs. 2, 3.4-3.7, 4.1-4.3, EUI – PWC Lecture, May 13, 2021.

Cochrane, John H., 2022, “The fiscal roots of inflation,” Review of Economic Dynamics, 45, 22 – 40.

Hall, George J. and Thomas Sargent, 2022. “Three world wars: Fiscal-monetary consequences,” Proceedings of the National Academy of Sciences, 119(18), 2200349119-, May Reis, Ricardo, 2021. “The constraint on public debt when r < g but g < m,” mimeo LSE. Sargent, Thomas J. 2012. “Nobel Lecture: United States Then, Europe Now,” Journal of Political Economy, 120, 1, 1-40.

5. Making sovereign debt safe: a proposal for a European Stability Fund.
I take a closer look into the peculiar European EMU design and the euro area experience. I focus on the current development of the Fiscal Union and how it can be improved. For this, I first discuss the rationale and constrained-efficient design of a Fiscal Union and the possible interventions of the ECB.

(*) Ábrahám, Árpad, Eva Cárceles-Poveda, Yan Liu and Ramon Marimon, 2024. “On the Optimal Design of a Financial Stability Fund,” Review of Economic Studies (c.a.).

Bassetto, Marco, and Gherardo Caracciolo, 2021. “Monetary/Fiscal Interactions with Forty Budget Constraints,” Working Papers 788, Federal Reserve Bank of Minneapolis.

Bocola, Luigi and Alesssandro Dovis, 2019. “Self-Fulfilling Debt Crisis: A Quantitative Analysis,” American Economic Review109 (12), 4343-4377.

Callegari, Giovanni, Ramon Marimon, Adrien Wicht and Luca Zavalloni, 2023. "On a Lender of Last Resort with a Central Bank and a Stability Fund" , Review of Economic Dynamics, 50, 106-130.

5 Chari, V., Alessandro Dovis and Patrick Kehoe, 2020. “Rethinking Optimal Currency Areas,” Journal of Monetary Economics, 111©, 80-94.

Dovis, Alessandro, 2019. “Efficient Sovereign Default,” Review of Economic Studies, 86, 282-312 Farhi, Emmanuel and Ivan Werning, 2017. “Fiscal Unions,” American Economic Review, 107(12), 3788-3834.

Ferrari, Alessandro, Yan Liu, Ramon Marimon and Chima Simpson-Bell, 2024. "Fiscal and Currency Union with Default and Exit," EUI.
(*) Liu, Yan, Ramon Marimn and Adrien Wicht, 2023."Making Sovereign Debt Safe with a Financial Stability Fund," 2023, International Economic Journal, 145, 103834.

Marimon, Ramon and Adrien Wicht, 2021. “Euro area fiscal policies and capacity in postpandemic times” (with), European Parliament, Economic Governance Support Unit, PE 651.392.

Marimon, Ramon, Adrien Wicht and Luca Zavalloni, 2024. “Risk Sharing and Reduction with Moral Hazard and Safe Debt”. EUI.

Mendoza, Enrique and Vivian Yue, 2012. “A General Equilibrium Model of Sovereign Default and Business Cycles”, The Quarterly Journal of Economics, 127, 889–946.

Mu¨ller, Andreas, Kjetil Storesletten and Fabrizio Zilibotti, 2019. “Sovereign Debt and Structural Reforms,” American Economic Review, 109(12), 4220 – 4259.

Niemann, Stefan and Paul Pichler, 2020. ”Optimal Fiscal Policy and Sovereign Debt Crises”, Review of Economic Dynamics, 37. 234-254

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