KECD 2105 - MACROECONOMICS 3 : Heterogeneity and Finance

This course presents recent developments in macroeconomic theory and modeling.

- First, the dynamic of the economy is hard to understand if one does not consider the dynamic of heterogeneity (or inequality) across agents.
The notion of heterogeneity should be broadly understood. It concerns households (wealth inequality is now widely discuss), but also firms, the heterogeneity of which is increasing and even countries. The tools to analyze these agents are similar.

Second, the role of financial imperfection in economic dynamics is an old and very active field of research: credit constraints, liquidity and bubbles are widely studied. Heterogeneity and financial imperfections are deeply related, as will become clear in the course. Hence, some notions of macro-finance will be introduced. The tools will refer to empirical facts, but will mostly introduce theories and tools to introduce those facts in macroeconomics.

The associated classes will be taught by XXXXXXX. Importantly, these classes will be methodological for you to master new technical tools.
He will introduce markov chains, dynamic programming tools and aspects of computational economics.
.

Xavier RAGOT,Paloma PÉLIGRY

Cours magistral et conférences

English

Lectures:
1 Introduction : Heterogeneity, inequality and basic asset pricing
1. Households Inequality : basic facts
2. Macroeconomic and microeconomic risk
(a) Talent, luck and returns
(b) Firm heterogeneity, Country Heterogeneity
(c) Incomplete market and Heterogeneity
3. Finance and asset prices : A primer

Associated class : Complete and incomplete market models : a formal treatment
References are:
• Attanasio, O., and L. Pistaferri (2016): “Consumption Inequality,” Journal of Economic Perspectives, 30(2), 3–28.
• Fagereng, A., L. Guiso, D. Malacrino, and L. Pistaferri (2016): “Heterogeneity and Persistence in Returns to Wealth,” Mimeo.
• LeGrand, F., and X. Ragot (2018): “A Class of Tractable IncompleteMarket Models for Studying Asset Returns and Risk Exposure,” European Economic Review.
• Milanovic, B. (2016): Global Inequality : A New Approach for the Age of Globalization. The Belknap Press.
• Parker, J., and A. Vissing-Jorgensen (2003): “The skill content of recent technological change : An empirical exploration,” Quarterly Journal of Economics, pp. 1279–1333.
• Parker, J., and A. Vissing-Jorgensen(2009): “Who Bears Aggregate Fluctuations and How?,” American Economic Review, 99(2), 399–405.
• Piketty, T. (2014): Capital in the Twenty-first Century. The Belknap

Websites :
• “World Inequality Database” : https://wid.world • Bob Shiller webpage “http://www.econ.yale.edu/~shiller/data.htm”. 2 Saving, asset prices : The price of risky asset in two period models 1. The basic portfolio problem (a) The equity premium (b) Preferences : Habits, (c) Incomplete market and precautionary savings

Associated class : Stochastic environments Markov Chains
References
• Barro, R.J. (2009), Rare Disasters, Asset Prices, and Welfare Costs, American Economic Review, 99(1), 243-264.
• Epstein, L.G. and Zin, S.E. (1989), Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns, Econometrica, 57(4), 937-969.
• Kocherlakota, N.R. (1996), The Equity Premium: It's Still a Puzzle, Journal of Economic Literature, 34(1), 42-71.
• Mehra, R. and Prescott, E.C. (1985), The Equity Premium: A Puzzle, Journal of Monetary Economics, 15(2), 145-161.
Textbook
• Cochrane J. H., Asset Pricing, Princeton University Press, 2009.
3 Saving, asset prices : Introducing financial imperfections
1. Incomplete market and precautionary savings
2. limited participation

Associated class :
References
• Mankiw, N. Gregory, 1986. “The Equity Premium and the Concentration of Aggregate Shocks,” Journal of Financial Economics 17, 211-219.
• Krusell, P., T. Mukoyama, and A. A. J. Smith (2011): “Asset Prices in a Huggett Economy,” Journal of Economic Theory, 146(3), 812–844.
• Guvenen, F. (2009), “A Parsimonious Macroeconomic Model for Asset Pricing', Econometrica
4 Modeling intertemporal problems: Dynamic programming
1. A new tool to solve dynamic problems
2. Bellman equations

Associated class : dynamic programming
References
• “Chapter 3 : Dynamics Programming”, Sargent Ljunqvist “recursive macroeconomic theory”, MIT Press.
• Stockey, nancy and Lucas, Robert “Recursive Methods in Economic Dynamics”, Harvard University Press, 1989. (Very advanced)
5 Credit constraints and the macroeconomy
1. The financial accelerator
2. Credit constraints and liquidity

Associated class : dynamic programming in practice
References
• Bernanke, B.S. and Gertler, M. (1989), ‘Agency costs, net worth, and business fluctuations', American Economic Review, 79(1), 14-31.
• Bernanke, B.S., Gertler, M. and Gilchrist, S. (1999), ‘The financial accelerator in a quantitative business cycle framework', Handbook of Macroeconomics
• Holmström, B. and Tirole, J. (1997), ‘Financial intermediation, loanable funds, and the real sector', Quarterly Journal of Economics, 112(3), 663691.
• Kiyotaki, N., & Moore, J. (1997). Credit Cycles. The Journal of Political Economy, 105(2), 211- 248.
• Iacoviello, Matteo. 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle." American Economic Review, 95 (3): 739-764.
• Woodford, Michael, “Public Debt as Private Liquidity,” American Economic Review, 1990, 80 (2), 382–388.
6 Modeling heterogeneity and inequalities in the macroeconomy: Incomplete market models
1. The basic incomplete market economy

Associated class : dynamic programming in a stochastic environment
References
Aiyagari, S.R. (1994), Uninsured Idiosyncratic Risk and Aggregate Savings, Quarterly Journal of Economics, 109(3), 659-684. 10
Huggett, M. (1993), The Risk-Free Rate in Heterogenous Agent Incomplete
Insurance Economics, Journal of Economic Dynamics and Control, 17, 953-969.
• De Nardi, M. (2015). Quantitative Models of Wealth Inequality: A Survey, No 21106, NBER Working Papers
• “Chapter 18 : Incomplete Market Models”, Sargent Ljunqvist “recursive macroeconomic theory”
7 Solving incomplete market models
1. Models without aggregate shocks
2. Models with aggregate shocks
• Hubmer, Joachim, Krusell, P. and T. Smith (2016) “The Historical Evolution of the Wealth Distribution : A Quantitative-Theoretic Investigation”, NBER Working paper 23011.
• Kaplan, G. and G. Violante (2014), “A Model of the Consumption Response to Fiscal Stimulus Payments”, Econometrica, 82, 1199-1239.
• Krueger, Dirk, Mitman, Kurt and Perri, Fabrizio, “Macroeconomics and Heterogeneity, Including Inequality” Hanbook of Macroeconomics, Vol. 2 2016
• Krusell, P. and T. Smith (2006), “Quantitative Macroeconomic Models with Heterogeneous Agents”, in Advances in Economics and Econometrics: Theory and Applications, Ninth World Congress.
8 Understanding market incompleteness : simple frameworks
1. Zero-liquidity environments
(a) Quasi-linear environments
(b) Recent applications to the “Paradox of thrift”
References
• M. Ravn and V. Sterck, “Macroeconomic fluctuations with Hank adnd Sam : An Analytical Approach”, Journal of the European Economic Association, March 2020
Krusell, P., T. Mukoyama, and A. A. J. Smith (2011): “Asset Prices in a Huggett Economy,” Journal of Economic Theory, 146(3), 812–844.
Ragot, 2018, “Heterogeneous agents in the Macroeconomy: Reduced-heterogeneity representations”, Handbook Chapter, in Handbook of Computational Economics, vol. 4. 2018”
9 HANK - model
1. Simple environment
(a) Richer environment and the question of the empirical Marginal Propensity to Consume
• Challe, E., J. Matheron, X. Ragot and J. Rubio-Ramirez (2017), “Precautionary Saving and Aggregate Demand”, Quantitative Economics.
• Kaplan, Greg, Benjamin Moll, and Giovanni L. Violante (2018), “Monetary Policy According to HANK” American Economic Review 2018, 108(3): 697–743
• Krusell, P. and Smith, A.A. (1998), Income and Wealth Heterogeneity in the Macroeconomy, Journal of Political Economy, 106(5), 867-896.
• McKay, A. and R. Reis (2016), “The Role of Automatic Stabilizers in the U.S. Business Cycle”, Econometrica.
10 Sovereign default
1. The logic of default
(a) Introduction to the eaton and Gersovitz environment.
References
• Aguiar, M., and M. Amador (2015): “Chapter 11 - Sovereign Debt,” in Handbook of International Economics, ed. by E. Helpman, K. Rogoff, and G. Gopinath, vol. 4 of Handbook of International Economics, chap. 11, pp. 647–687. Elsevier.
• Aguiar, M., and G. Gopinath (2006): “Defaultable Debt, Interest Rates and the Current Account,” Journal of International Economics, 69(1), 64– 83.
• Arellano, C. (2008): “Default Risk and Income Fluctuations in Emerging Economies,” American Economic Review, 98(3), 690–712.
• Bulow, J. I., and K. S. Rogoff (1989): “Sovereign Debt: Is to Forgive to Forget?,” American Economic Review, 79(1), 43–50.
Calvo, G. A. 1988. "Servicing the Debt: The Role of Expectations," American Economic Review 78, 647-661.
Eaton, J., and M. Gersovitz (1981): “Debt with Potential Repudiation: Theoretical and Empirical Analysis,” Review of Economic Studies, 48(2), 289–309.
• Livshits, I., J. MacGee, and M. Tertilt (2007): “Consumer Bankruptcy: A Fresh Start,” American Economic Review, 97(1), 402–418.
• Tomz, M., and M. L. J. Wright (2013): “Empirical Research on Sovereign Debt and Default,” Annual Review of Economics, 5(1), 247–272.
• LeGrand F. Ragot X. (2021), Sovereign Default and Liquidity: The Case for a World Safe Asset, forthcoming in Journal of International Economics.
11 Heterogeneous firms
1. Idiosyncratic risk at the firm level and capital misallocation
(a) A simple model
(b) Recent literature (Kahn and Thomas, Winberry, and so on) References
• Khan, Aubhik and Julia K Thomas (2013), ‘Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity', p. 59.
• Khan, Aubhik, Tatsuro Senga and Julia K Thomas (2017), ‘Default Risk
• Hsieh and Klenow, “Misallocation and Manufacturing TFP in China and India”, Quarterly Journal of Economics, 2009.
• Martin-Baillon, Alais “Optimal Fiscal Policy with Heterogeneous Firms and Aggregate Shock”, Job-Market paper.
12 Recent developments: Defining the proper policies
• Bhandari, Golosov, Evans, Sargent (2020) “Inequality, Business Cycles and Monetary-Fiscal- Policy
• LeGrand Ragot (2019), Managing inequalities over the business cycle”, forthcoming in International Economic Review.

Autumn 2025-2026

The final grade will computed as follows:

1. Problem Sets (20 % Final Grade)
2. Midterm Exam (20 % Final Grade)
3. Final Exam (60 % Final Grade)