Oslo Summer School in Comparative Social Science Studies 2003

Macroeconomics and Inequality

Lecturer: Professor Per Krusell,
Department of Economics, University of Rochester, USA

Main discipline: Economics
Dates: 4. - 8. August 2003

Traditional macroeconomic models postulate relations between aggregate variables such as output, inflation, and unemployment. More modern treatments derive such relations on the basis of a microeconomic model with a "representative-agent" construct. Such models, while being more satisfactory in a number of ways-such as having the potential for examining welfare consequences of policy experiments-lacks in two important dimensions: (i) it is unrealistic in that it builds on the assumption of aggregation across households into one agent, thus potentially casting doubt on the positive and normative value of the model; and (ii) by not explicitly considering di_erences across households in the economy, it is not useful for addressing issues that have always been part of the macroeconomic debate: issues of inequality, and how inequality is affected by, and affects, macroeconomic variables and macroeconomic policy.

The objective of this course is to develop frameworks for analyzing the interaction between macroeconomics and inequality in model settings that are suited both for positive and normative analysis-that rest on solid microfoundations. The beginning of the course will review basics about when aggregation holds and does not hold. Then various departures from the assumptions that guarantee aggregation will be considered. Most of this analysis will take place with models that only allow numerical solution. Numerical solution techniques will not be an objective in itself in this course, but some techniques will be briefly discussed.

The course will relatively quickly move to the research frontier, and the material will therefore be demanding. Knowledge of dynamic programming will be presupposed. There are, as of the moment of writing this course plan, only a small number of papers carrying out analyses of the sort that this course aims to develop. This reflects the degree of difficulty and ambition of this kind of research, but at the same time it indicates the value of knowing and applying the techniques. Potential applications abound.

The course will be based on papers from the literature on macroeconomics and inequality. As seen above, readings include lecture notes on aggregation, basic papers by Huggett and Aiyagari without aggregate uncertainty, papers by Krusell and Smith with uncertainty, and a number of other papers. A more detailed reading list will be provided later.

Outline of Lectures

The following outline is preliminary and covers 10 2�45-minute lectures.

Lecture 1: Aggregation with and without recursive methods.
Steady states and dynamics.

Lecture notes and Krusell and R��os-Rull AER 1999.

Lecture 2: Incomplete markets I: no aggregate uncertainty, infinitely lived agents.
The Huggett model.

Huggett JEDC 1993.

Lecture 3: Incomplete markets I, cont'd.
The Aiyagari model.

Aiyagari QJE 1994.

Lecture 4: Incomplete markets II: no aggregate uncertainty, overlapping generations.
Some models by Huggett, Laitner, and others.

Papers by Huggett, Laitner, and others

Lecture 5: Incomplete markets III: aggregate uncertainty, infinitely lived agents.
The Krusell and Smith model.

Krusell and Smith JPE 1998.

Lecture 6: Incomplete markets IV: aggregate uncertainty, overlapping generations.
The models developed by Storesletten, Telmer, and Yaron, and by Gourinchas.

Papers by Storesletten, Telmer, and Yaron, and by Gourinchas.

Lecture 7: Incomplete markets V: portfolio issues and incomplete market participation.
How asset prices/risk premia determined in models with inequality? Why do some people hold stocks and others not? What is the reason for the absence of markets/full market participation?

Papers by Heaton and Lucas, Constantinides and Du_e, Krusell and Smith, Storesletten, Telmer, and Yaron, and Guvenen as well as a brief discussion of the dynamic contracting literature (see, e.g., Ljungqvist and Sargent's book).

Lecture 8: Policy issues I: the welfare costs of business cycles.
Work within various paradigms, including the one focused on here; with substantial inequality: who is hurt how much by cycles?

The literature starting with Lucas's famous paper up to and including recent work by Krusell and Smith, Krebs, and Storesletten, Telmer, and Yaron.

Lecture 9: Policy issues II: other macroeconomic policies and how they determine, and may be influenced by, inequality.
Some open issues about stabilization policy and other macro policies and how they interact/compare with social insurance and other inequality-related policies. Political economy may be touched upon as well here.

None - this is current work/ideas.

Lecture 10: The labor market: can we integrate the above literature with stories of frictional labor markets?
A discussion of the Diamond/Mortensen/Pissarides frameworks in this context.

None - this is current work/ideas.

The Lecturer
Per Krusell is a Professor of Economics at the University of Rochester, USA, and also holds a part-time Visiting Professor position at the Institute for International Economic Studies in Stockholm, Sweden. At Rochester, he is the Director of the Center for the Study of Economic Cycles and Growth as well as a Codirector of the Wallis Institute of Political Economy. After undergraduate and graduate studies in Stockholm, he completed his PhD in economics at the University of Minnesota in 1992. Prior to his position at Rochester he held positions at Northwestern University and at the University of Pennsylvania.

His work is in macroeconomics broadly defined, with specializations within the fields of economic growth and technological change, political economy and public economics, inequality, and behavioral economics. His research has appeared in journals such as the Journal of Political Economy, Econometrica, and the American Economic Review. He is an editor of the B.E. Journals in Macroeconomics and an associate editor of the Review of Economic Dynamics.