Calibration in Macroeconomics

Abstract

Macroeconomic models allow us to perform policy counterfactuals related to inequality, monetary policy, and trade. But to believe our predictions, the models’ parameters must be reasonable. Calibration is the process of choosing parameters (usually related to technology and preferences). This course explores common approaches with applications to inequality, trade, finance, and monetary policy.

Objective

Using examples from both classic and frontier papers in quantitative macroeconomics, this course teaches students popular approaches to calibrating models and evaluating model fit. While the emphasis is on calibration methodology, students will also learn about a variety of model solution algorithms, key datasets, standard parameter values, and the contributions/takeaways of the various papers. After taking this course, students will be able to: - understand and implement the main approaches to calibration - assess the plausibility and fit of calibrations in new papers or their own research - integrate standard functional forms and parameter values into their research - gather and analyse key datasets used in calibration - understand the basics of a variety of solution algorithms for equilibrium models Additionally, the course gives students a sense of the frontier of research in some of the fields covered.

Content

The course is designed for PhD students in economics, finance, and related fields, especially those who wish to use quantitative macroeconomic models for research or policy. Enrolling students should have experience with graduate-level economic theory and be able to code in one of the programming languages commonly used in macroeconomics (e.g., Matlab, Python, Julia, Fortran, etc.). The purpose of the course is to show students how calibration is and has been used in quantitative macroeconomics. The predictions and implications of macroeconomic models – the costs of trade barriers, the causes of changes in inequality, the effects of fiscal and monetary policy shocks, and the consequences of sovereign default for example – depend on the underlying parameters. Typical parameters include consumer risk aversion and patience, firm and consumer elasticities of substitution, the variance and persistence of shocks to firms and consumers, and credit constraints. To believe the welfare implications, counterfactuals, or forecasts of our models, the parameters must be set to “reasonable” values. Calibration is the process of choosing reasonable parameters using, for example, previous research, estimates from microeconomic data, or the comparison of model moments with empirical counterparts. Calibration is an essential tool in macroeconomics. It is employed in a large fraction of the academic literature as well as in many influential policy analyses. The course is directed towards researchers interested in the frontier of macroeconomic theory, but it is also relevant for anyone working on policy-related theoretical models in public finance, trade, and international finance. The instructor will prepare and present lecture slides, but class discussion is strongly encouraged. Students are expected to read the papers assigned for each week. Assessment is based on a final project: each student must replicate the main result of a paper from the class or another paper approved by the instructor.

Resources