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   Course Title    Marcoeconomic Adjustment and Small Open Economy Programming
Lecturer    Natalja Lubenets
Institution    Tallinn Technical University
Country    Estonia


Introduction

Any small open economy is subject to numerous external shocks that shift this economy from its equilibrium level. The aim of macroeconomic adjustment is to stabilize the economic equilibrium using the built-in financing resources to eliminate the misbalances. Conventional and modern economic theories allow for two adjustment mechanisms: automatic or self-adjustment and discretionary (economic policy) adjustment. Both kinds of adjustments occur under fixed or flexible exchange rate through changes in price level, interest rates and income. Return to the equilibrium may occur in the short-run or be a result of the long-run structural adjustment policies based on the macroeconomic programming.

Aim and objectives

The aim of this course is to provide an insight to macroeconomic adjustment theories applicable to small open economies and to build a programming framework that enables to analyse the different adjustments policies.

Thus, it is possible to extract the following objectives of the course:

  • To develop and understand main theoretical approaches to small open economy modelling (Keynesian model, IS-LM-BOP model, AS-AD model)
  • To be able to analyse the effects and evaluate the effectiveness of adjustment policy under different exchange rate frameworks
  • To understand the objectives and aims of macroeconomic programming and learn the programming methodology
  • To develop programming frameworks for main sectors of small open economy

After the successful completion of the course student should be able to understand the main adjustment mechanisms in the economy and to forecast the outcomes and impacts of different stabilization strategies.

General description of the course

The course will consist in two parts. Macroeconomic adjustment part of the course will explore the related issues of automatic and discretionary macroeconomic adjustment in small open economy. The question of the existence of an automatic adjustment mechanism in the international economy will be addressed first under basic Keynesian framework adopted for small open economies. The course will then analyse formation of internal and external macroeconomic equilibriums under IS-LM-BP model. Introduction of flexible prices into the adjustment models will be covered under AS-AD framework. Obstacles to the smooth functioning of such a mechanism will be also considered. Discretionary macroeconomic stabilisation section questions the efficacy of fiscal and monetary policies in determining levels of income and employment under combinations of fixed and flexible exchange rates and fixed and flexible prices (Mundell-Fleming framework). In addition, the related investigation of the effects on the domestic economy of various external and internal disturbances is undertaken.

Macroeconomic programming part of the course considers the application of basic theoretical model of macroeconomic programming to small open economy analysis. Different sets of variables (targets, endogenous and exogenous variables, policy instruments) will be identified and applied to programming real, government, monetary and BOP sectors of an economy. This includes basic sectoral balance models and major types of policy development. The empirical studies will cover different aspects of programming based on the evidence from transition economies. The applied part of the course will attempt to analyse and forecast major dynamics of price level, budget sector, monetary growth as well as trade and capital flows.

Syllabus

The course will constitute 16 hours of lectures (14 lectures plus 2 mid-exams) and 8 hours of seminars taught over 16 weeks (one academic semester)

I. Macroeconomic adjustment in a small open economy

IA Automatic adjustment

Lecture 1: Income-output and IS-LM-BOP models

1.1 Basic model for closed economy (Keynesian model)

1.2 Macroeconomic adjustment model for small open economy

1.3 Internal and external balances and IS, LM and BP curves

1.4 Economic analysis in IS-LM-BP model

Lecture 2: Aggregated demand and aggregated supply in an open economy (AS-AD model)

2.1Structure of a model

2.2 Economic analysis in AD-AS framework

2.3 Economic equilibrium in AD-AS framework

Lecture 3: Macroeconomic adjustment to the exogenous shocks in an open economy

3.1 Real economic shocks: world and domestic price shocks

3.2 Monetary shocks: world and domestic interest rate shocks

IB Discretionary adjustment

Lecture 4: Mechanisms of discretionary adjustments

4.1 Objectives and instrument of macroeconomic adjustment

4.2 Economic diagnostics (Swan and Mundell-Fleming diagrams)

4.3 Principle of effective market classification

Lecture 5: Discretionary adjustment under fixed exchange rate

5.1 Fiscal policy

5.2 Monetary policy

5.3 Exchange rate policy

5.4 Policy mix

Lecture 6: Discretionary adjustment under flexible exchange rate

6.1 Fiscal policy

6.2 Monetary policy

6.3 Exchange rate policy

6.4 Policy mix

Lecture 7: Discretionary adjustment and prices

7.1 Fiscal policy under fixed exchange rate

7.2 Monetary policy under flexible exchange rate

7.3 Adjustment and high-quality economic growth

Lecture 8: Mid-exam I (Lectures 1-7)

II Macroeconomic programming for a small open economy

IIA Programming methodology

Lecture 9: Key elements of economic programs

9.1 Programming objectives

9.2 Classification of economic programs

9.3 Composition of economic programs

9.4 Adjustments of demand and supply

Lecture 10: Theory of macroeconomic adjustment programming

10.1 Basic balance model

10.2 BOP model

10.3 Fiscal balance model

10.4 Central Bank balance model

10.5 Exchange rate policy adjustments

Lecture 11: Demand- and supply-side policies

11.1 Monetary and fiscal policy instruments

11.2 Exchange rate, trade and debt-regulating policy

11.3 Optimization of factor use

11.4 Enlargement of production possibilities frontier

IIB Programming the elements of a small open economy

Lecture 12: Real sector programming

12.1 Structure of a real sector

12.2 Data aggregation

12.3 Forecasting the industrial output

12.4 Saving-Investment balance

12.5 Inflation forecasting

Lecture 13: Fiscal programming

13.1 Structure of a budget sector

13.2 Fiscal aggregates

13.3 Budget forecasting

Lecture 14: Monetary sector programming

14.1 Structure of monetary sector

14.2 Monetary aggregates

14.3 Monetary sector forecasting

Lecture 15: Open-sector programming

15.1 Open-sector structure and aggregates

15.2 Current account forecasting

15.3 Capital account forecasting

Lecture 16: Mid-exam II (Lectures 9-15)

Teaching methods

Two hours each week will be devoted to a lecture. Students are expected to do specified background reading before each lecture in order that they participate and enjoy it. Handouts will be provided. Two hours every second week will be devoted to a seminar discussion or a workshop on a topic related but not identical to the lecture material. The objective of a seminar work is to provide practical skills in economic programming. Thus, students are expected to master the theoretical material relevant to the following seminar session.

Assessment

Students will face two mid-exams (closed-book) during this course. The best of the two results will comprise 25% of a final grade. Students, whose 2 mid-exam mean will be above 80 can get the final grade (either high or excellent) without passing the final examination. The aim of this clause is to encourage students to participate more actively in the course and to reward the best students. The final will be closed book 1.5 hour written examination focusing on combination of theory and methodology of policy analysis. Students are expected to perform graphic analysis and present an economic evaluation. The result of the final will comprise 75% of the final grade.

Reading list and information sources

Required readings:

Blanchard, O. Macroeconomics. II Ed., 2000

Kireyev, A. Mezhdunarodnaya Economica II part. Textbook. Mezhdunarodnye Otnosheniya, Moskow, 2000

Krugman, P. and Obsfeld, M. International Economics: Theory and Policy, Addison-Welsley, Mass., 1997

Obsfeld, M. and Rogoff, K. Foundations of International Macroeconomics. MIT Press, 1996

The Handbook of International Macroeconomics. Blackwell, Mass., 1994

Complementary readings:

Balance of Payments Textbook, IMF, 1996

Bradley, J., A. Kangur and I. Kearney. HERMIN HE4 A medium-term macro-model of Estonia: structure, properties and forecasts. Working Paper, ESRI, Dublin, 2001

ESRC Macroeconomic Modelling Bureau Discussion Papers, available in the Internet, http://www.warwick.ac.uk/fac/soc/Economics

Institute of International Economy, Washington, http://www.iie.com

International Monetary Fund Publications, http://www.imf.org

 



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