Economics 504, Part 2, Spring 2007 Princeton University 

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Courses 2006-07: 504 522 554 | Blackboard | Calendars | Students | Graduate Program 

504 Macroeconomic Theory II

Economics 504 is the second semester of an integrated two-semester sequence in macroeconomics, required for first-year Ph.D. students in economics.  It assumes that students have already taken the previous semester of this sequence, Economics 503.  As with Economics 503, the requirements of the course include attendance at the lectures, completion of a series of problem sets, and a final exam for each part. 

Part 2 is taught by Lars Svensson

Announcements regarding part 2 will be made on this page, and the page will be frequently updated. Students are required to check the page regularly.

Extra class on Monday, May 7, 1-2:30pm, B-06 Fisher.
Problem set 3 posted (corrected 5/2/07).   
Final exam moved to Thursday, May 17, 9am-12noon.

Part 2: Monetary Theory and Policy

The second half of Economics 504 in the Spring 2007 Graduate Program, Department of Economics, Princeton University

Teacher: Lars Svensson, Office: 106 Fisher Hall, Tel: 258-0329, Email:
Office hours:
By appointment (send email to get appointment). 
Administrative assistant:
Kathleen Hurley, Office: 107 Fisher Hall, Tel: 258 4023, Email:

Class schedule: Monday and Wednesday, 1:00-2:30pm, B-06 Fisher. 
Part 2 starts Monday, Mar 26, and ends Wednesday, May 2.
Extra class on Monday, May 7.

Preceptor: Alisdair McKay, Email:
Precept schedule: Wednesday, 2:40-3:40pm.
First-year students 2006-07

Final exam for part 2: Thursday, May 17, 9-11am, B-06 Fisher.

Exam with solutions to problems 1 and 2

Prerequisites: Students are expected to be familiar with the material in Economics 503, Macroeconomic Theory I, in the Fall 2005 Graduate Program. 

Requirements for part 2: Attendance at lectures and precepts; completion of a series of problem sets; and a final exam.

Slides: Copies of slides or notes in the form of pdf files will be available before each class on this page. Students are expected to download and print these before each class.

Notice: These slides are not self-contained but incomplete. They are not a substitute for coming to class. In particular, the slides are simplified and sometimes provocative. They should therefore not be interpreted as definitive statements. The slides should never be quoted without my permission.

Lecture notes 1
Cagan figure (revised 3/26/07)
Lecture notes 2
Lecture notes 3
Gali Figure
Lecture notes 4
Lecture notes 5
Lecture notes 6
"Optimization under Commitment and Discretion, the Recursive Saddlepoint Method, and Targeting Rules and Instrument Rules: Lecture Notes"
Lecture notes 7
Lecture notes 8 

Problem sets:  Solutions to the problem sets will be graded and have about 15% weight in the final grade for the course. Students are allowed to cooperate on the solutions, but each student has to submit individual solutions.

Problem Set 1 (revised 4/4/07) (to be handed in to the preceptor at the class on Wednesday, April 11)
Problem Set 2 (to be handed in to the preceptor at the class on Monday, April 23)
Problem Set 3 (corrected 5/2/07) (to be handed in to the preceptor on Monday, May 7)

Errors: Please email me about any errors, for instance, in the reading list, the URLs, the notes, or the slides.

Readings and course plan (preliminary)   

* indicates required reading. Other readings are suggested but not required.

Several of the topics that we shall take up are treated in three books, Obstfeld and Rogoff (1996), Walsh (2003), and Woodford (2003). These books are also good general references. A good book on U.S. institutional detail is Mishkin (2001) (this is the 6th edition, but any edition from the 4th is fine). Ljungqvist and Sargent (2004) is a good reference on recursive methods in macroeconomics.

Students are expected to find most of the readings on the web. Learning to find your way to the monetary-policy literature on the web is part of the course. Use links to authors' personal homepages (this usually gives you the most recent copy), central bank's publications and working papers, NBER working papers, CEPR discussion papers, JSTOR, the PU Library e-journals, etc. Some restricted material is available here.  

1. Money and inflation

Cagan (1956).
*Obstfeld and Rogoff (1996, sec. 8.2).  

Pearson (1990, sec. 19.2.1). 
Sargent (1993).

2. An optimizing model of money demand and Friedman's rule

Friedman (1969).
Lucas (2000). 
*Obstfeld and Rogoff (1996, sec. 8.3). 
Svensson (1993).
Walsh (2003, chap. 2 and sec. 4.4-4.5) 
Woodford (2003, chap. 2).

3. Evidence of real effects of monetary disturbances  

Bernanke and Mihov (1998). 
Christiano, Eichenbaum and Evans (1999).  
Gali (2001).
Issing, Gaspar, Angeloni and Tristiani (2001, chap. 1). 
Nelson (2003).
*Walsh (2003, chap. 1). 

4. The transmission of monetary policy: Aggregate demand, aggregate supply and expectations

Blinder, Canetti, Lebow and Rudd (1997).  
*Clarida, Gali and Gertler (1999).
Dixit and Stiglizt (1977).
Estrella and Fuhrer (1998). 
Friedman (1968).
Gali and Gertler (1999). 
*King (2000).
Lucas (1976, especially sec. 5.3).
Mankiw and Reis (2002). 
*Mishkin (1995). 
Nelson (2003). 

Sbordone (1998).
Walsh (2003, secs. 5.3-5.5). 

Woodford (2003, chap. 3).

5. A framework for analyzing monetary policy: goals, targets, indicators and instruments 

Clarida, Gali and Gertler (1999).
Marcet-Marimon (1998).  
*Söderlind (1999). 
*Svensson (1999).
Svensson and Woodford (2005). 
Woodford (1999). 

6. Commitment, discretion and optimal delegation in monetary policy

Blinder (1998, chap. 2, sec. 4). 
Clarida, Gali and Gertler (1999). 
Kydland and Prescott (1977). 
McCallum and Nelson (2000). 
Söderlind (1999). 
Svensson (1997b).
Walsh (2003, chap. 8).  

7. The evolution of monetary policy rules and the Taylor rule 

*Bernanke (2006b, last three paragraphs)
Hetzel (2000).
Kozicki (1999)  
Taylor (1993).
Taylor (2000).
*Woodford (2001). 

8. Inflation targeting  

*Bernanke (2006a)
Bernanke, Laubach, Mishkin and Posen (1999, chap. 10).
Bernanke (2004). 
Giannoni and Woodford (2002). 
*IMF (2005, WEO Chapt. IV)
King (2002).
McCallum and Nelson (2004).
Norges Bank (2005, Section 1).   
Svensson (1997, 1999). 

*Svensson (2001a, 2003b).
Svensson (2004).
Truman (2003).
Vickers (1998). 
Woodford (2000). 

9. Monetary policy in a liquidity trap and deflation 

Clouse, Henderson, Orphanides, Small and Tinsley (2000). 
Bernanke (2000).
Krugman (1998). 
Svensson (2001c)
Svensson (2003a). 
Woodford (2003, chap. 2).  


Ball, Laurence, and Niamh Sheridan (2003), "Does Inflation Targeting Matter?" working paper.
Bank of Canada (1994), Economic Behaviour and Policy Choice Under Price Stability, Bank of Canada.
Batini, Nicoletta, and Anthony Yates (2002), "Hybrid Inflation Targeting and Price Level Targeting," Bank of England Working Paper No. 135.
Bernanke, Ben S. (2000), "Japanese Monetary Policy: A Case of Self-Induced Paralysis?" in Adam Posen and Ryoichi Mikitani, eds., Japan's Financial Crisis and Its Parallels to US Experience, Special Report 13, Institute for International Economics, Washington, DC, 149-166.

Bernanke, Ben S. (2004), "The Logic of Monetary Policy," speech, Federal Reserve Board.
Bernanke, Ben S. (2006a), "The Benefits of Price Stability," speech at Princeton University, February 24,
Bernanke, Ben S. (2006b), "Testimony: Semiannual Monetary Policy Report to the Congress," February 15,
Bernanke, Ben S., Thomas Laubach, Frederic Mishkin and Adam Posen (1999), Inflation Targeting: Lessons from the International Experience, Princeton: Princeton Univ. Press. 
Bernanke, Ben S., and Ilian Mihov (1998), "Measuring Monetary Policy," Quarterly Journal of Economics 113, 869-902.
Bernanke, Ben S., and Michael Woodford, eds. (2005), The Inflation-Targeting Debate, University of Chicago Press.  
Blinder, Alan S. (1998), Central Banking in Theory and Practice, MIT Press. 
Blinder, Alan S., Elie R.D. Canetti, David E. Lebow and Jeremy B. Rudd (1997), Asking About Prices: A New Approach to Understanding Price Stickiness,  New York: Russell Sage Foundation. 
Cagan, Phillip (1956), "The Monetary Dynamics of Hyperinflation", in M. Friedman, ed., Studies in the Quantity Theory of Money, University of Chicago Press. 
Calvo, Guillermo (1983), "Staggered Prices in a Utility-Maximizing Framework," Journal of Monetary Economics 12, 983-998.
Calvo, Guillermo , Oya Celasun and Michael Kumhof (2001), "A Theory of Rational Inflation Inertia," Working Paper.
Cecchetti, Stephen G., and Junhan Kim (2003), "Inflation Targeting, Price Level Targeting and Output Variability," working paper.
Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans (1999), "Monetary Policy Shocks: What Have We Learned and To What End?" in Taylor, John B., and Michael Woodford, eds., Handbook of Macroeconomics, vol. 1A, North-Holland.  

Clarida, Richard, Jordi Gali, and Mark Gertler (1999), "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature 37, 1661-1707.  
Clouse, James, Dale Henderson, Athanasios Orphanides, David Small and Peter Tinsley (2000), "Monetary Policy when the Nominal Short-Term Interest Rate is Zero,"  Finance and Economics Discussion Series no. 2000-51, Federal Reserve Board.
Dixit, Avinash K., and Joseph E. Stiglitz (1977), “Monopolistic Competition and Optimum Product Diversity,” American Economic Review 67, 297-308.   
Estrella, Arturo, and Jeffrey C. Fuhrer (1998), "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational Expectations Models," Working Paper no. 98-5, Federal Reserve Bank of Boston.
Friedman, Milton (1968), "The Role of Monetary Policy," American Economic Review 58, 1-17.   
Friedman, Milton (1969), "The Optimum Quantity of Money", in The Optimum Quantity of Money and Other Essays, Aldine. 
Gali, Jordi (2001), "Monetary Policy in the Early Years of EMU," Working Paper.
Gali, Jordi, and Mark Gertler (1999), "Inflation Dynamics: A Structural Econometric Analysis," Journal of Monetary Economics 44, 195-222.
Gerlach, Stefan, and Lars E.O. Svensson (2003), "Money and Inflation in the Euro Area: A Case for Monetary Indicators?" Journal of Monetary Economics 50, 1649-1672. 
Giannoni and Woodford (2002), "Optimal Interest-Rate Rules: I. General Theory," NBER Working Paper No. 9419.
Goodfriend, Marvin (2003), "Inflation Targeting in the United States," working paper, Federal Reserve Bank of Richmond.
Hetzel, Robert L. (2000), "The Taylor Rule: Is it a Useful Guide to Understanding Monetary Policy?" Quarterly Review, Federal Reserve Bank of Richmond, Spring 2000, 1-33.
International Monetary Fund (2005), World Economic Outlook, September 2005, 
Issing, Otmar, Vitor Gaspar, Ignazio Angeloni and Oreste Tristiani (2001), Monetary Policy in the Euro Area, Cambridge University Press.
King, Mervyn (2002), "The Inflation Target Ten Years On," speech on November 19, 2002, Bank of England.  
King, Robert G. (2000), "The New IS-LM Model: Language, Logic and Limits," Federal Reserve Bank of Richmond Economic Quarterly 86/3, 45-103.
Kozicki, Sharon (1999), "How Useful Are Taylor Rules for Monetary Policy?" Federal Reserve Bank of Kansas City Economic Review, Second Quarter 1999, 5-33.
Krugman, Paul (1998), "It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity 1998(2), 137-205. 
Kydland, Finn E., and Edward C. Prescott (1977), "Rules Rather than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy 85, 473-491.
Ljungqvist, Lars, and Thomas J. Sargent (2004), Recursive Macroeconomic Theory, 2nd edition, MIT Press, Cambridge, MA. 
Lucas, Robert E., Jr. (1976), "Econometric Policy Evaluation: A Critique," Carnegie-Rochester Conference Series on Public Policy,  1: 19-46. Reprinted in Lucas, Robert E., Jr. (1981), Studies in Business Cycle Theory,  Cambridge: MIT Press.
Lucas, Robert E., Jr. (2000), "Inflation and Welfare," Econometrica 68, 247-274.
Mankiw, N. Gregory, and Ricardo Reis (2002),
"Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Quarterly Journal of Economics 117,1295-1328.
Marcet, Albert, and Ramon Marimon (1998), "Recursive Contracts," working paper,
McCallum, Bennett T., and Edward Nelson (2000), "Timeless Perspectives vs. Discretionary Monetary Policy in Forward-Looking Models," NBER working paper no. 7915.
McCallum, Bennett T., and Edward Nelson (2004), "Targeting Rules vs. Instrument Rules for Monetary Policy," working paper. 
Mishkin, Frederic S. (1995), "Symposium on the Monetary Transmission Mechanism," Journal of Economic Perspectives 9(4), 3-10. 
Mishkin, Frederic S. (2001), The Economics of Money, Banking and Financial Markets, 6th edition, Addison-Wesley Publishing. (Any edition from 4th is fine.)
Nelson, Edward (2003), "The Future of Monetary Aggregates in Monetary Policy Analysis," Journal of Monetary Economics, forthcoming.
Norges Bank (2005), Inflation Report 3/2005, November,

Obstfeld, Maurice, and Kenneth Rogoff (1996), Foundations of International Macroeconomics,  MIT Press. 
Pearson, Carl E. (1990), Handbook of Applied Mathematics, 2nd ed., Van Nostrand Reinhold. 
Rotemberg, Julio J., and Michael Woodford (1997), "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Macroeconomics Annual 1997, 297-346. 
Rudebusch, Glenn, and Lars E.O. Svensson (1999), "Policy Rules for Inflation Targeting," in John B. Taylor (ed.), Monetary Policy Rules, University of Chicago Press, 1999.  
Rudebusch, Glenn, and Lars E.O. Svensson (2002),
"Eurosystem Monetary Targeting: Lessons from U.S. Data," European Economic Review 46, 417-442,
Sargent, Thomas (1993), "The Ends of Four Big Inflations", in Rational Expectations and Inflation, 2nd ed., HarperCollins.
Sbordone, Argia M. (1998), "Prices and Unit Labor Costs: A New Test of Price Stickiness," IIES seminar paper no. 653, Stockholm University. 
Söderlind, Paul (1999), "Solution and Estimation of RE Macromodels with Optimal Policy," European Economic Review 43, 813-823. 
Svensson, Lars E.O. (1993), "Term, Inflation, and Foreign Exchange Risk Premia: A Unified Treatment," NBER Working Paper No. 4544. 
Svensson, Lars E.O. (1997a), "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," European Economic Review 41 (1997), 1111-1146. 
Svensson, Lars E.O. (1997b), "Optimal Inflation Targets, 'Conservative' Central banks, and Linear Inflation Contracts," American Economic Review 87, 98-114. 
Svensson, Lars E.O. (1999), "Inflation Targeting as a Monetary Policy Rule," Journal of Monetary Economics 43, 607-654. 
Svensson, Lars E.O. (2001a)
"Inflation Targeting: Should It Be Modeled as an Instrument Rule or a Targeting Rule?" European Economic Review 46 (2002) 771-780.
Svensson, Lars E.O. (2001b), "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," in Deutsche Bundesbank, ed. (2001), The Monetary Transmission Process: Recent Developments and Lessons for Europe, Palgrave, New York, 60-102.
Svensson, Lars E.O. (2001c), "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies 19(S-1), February 2001, 277-312. 
Svensson, Lars E.O. (2003a), "
Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives 17-4 (Fall), 145-166, PDF.
Svensson, Lars E.O. (2003b), "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature
41, 426-477.
Svensson, Lars E.O. (2004),
"Targeting Rules vs. Instrument Rules for Monetary Policy: What Is Wrong with McCallum and Nelson?" working paper.
Svensson, Lars E.O., and Michael Woodford (2003), "Indicator Variables for Optimal Policy," Journal of Monetary Economics
50, 691-720.  
Svensson, Lars E.O., and Michael Woodford (2005), "Implementing Optimal Policy through Inflation-Forecast Targeting,"
in Bernanke, Ben S., and Michael Woodford, eds., The Inflation-Targeting Debate, University of Chicago Press, Chicago, 19-83. 
Taylor, John B. (1993), "Discretion versus Policy Rules in Practice," Carnegie-Rochester Conference Series on Public Policy 39, 195-214.
Taylor, John B. (1999), "A Historical Analysis of Monetary Policy Rules," in Taylor, John B., ed., Monetary Policy Rules, Chicago: Univ. of Chicago Press. 
Truman, Edwin (2003), Inflation Targeting and the International Financial System: Challenges and Opportunities, manuscript, Institute for International Economics.
Taylor, John B. (2000), "Using Monetary Policy Rules in Emerging Market Economies," in Stabilization and Monetary Policy: The International Experience, Bank of Mexico, pp. 441-457.
Vestin, David (2003), "
Price-level targeting vs inflation targeting in a forward-looking model," working paper.
Vickers, John (1998), "Inflation Targeting in Practice: The U.K. Experience," Bank of England Quarterly Bulletin, November 1998. 

Walsh, Carl E. (2003), Monetary Theory and Policy, 2nd edition, MIT Press.
Woodford, Michael (1996), "Control of the Public Debt: A Requirement for Price Stability?" NBER Working Paper No. 5684.

Woodford, Michael (2000),  "Pitfalls of Forward-Looking Monetary Policy," American Economic Review 90, 100-104.
Woodford, Michael (2001), "The Taylor Rule and Optimal Monetary Policy,"
American Economic Review 91, 232-237. 
Woodford, Michael (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press. 
Yun, Tack (1996), "Nominal Price Rigidity, Money Supply Endogeneity, and Business Cycles,” Journal of Monetary Economics 37, 345-370.

Courses 2006-07: 504 522 554 | Blackboard | Calendars | Students | Graduate Program

Home | New | Topics | Contact | Short bio | CV | Teaching | Links | Search | Princeton Econ | Princeton U | Google  

Revised februari 10, 2011 .
Comments and suggestions are welcome.