Macroeconomics blanchard (6th edition)

Flexible Organization Macroeconomics, sixth edition is organized around two central parts: A core and a set of two major extensions The text’s flexible organization emphasizes an integrated view of macroeconomics, while enabling professors to focus on the theories, models, and applications that they deem central to their particular course The flowchart below quickly illustrates how the chapters are organized and fit within the book’s overall structure For a more detailed explanation of the Organization, and for an extensive list of Alternative Course Outlines, see pages xiii–xv in the preface INTRODUCTION A Tour of the World Chapter A Tour of the Book Chapter THE CORE The Short Run The Goods Market Chapter Financial Markets Chapter Goods and Financial Markets: The IS-LM Model Chapter The Medium Run The Labor Market Chapter Putting All Markets Together: The AS-AD Model Chapter The Natural Rate of Unemployment and The Phillips Curve Chapter The Crisis Chapter The Long Run The Facts of Growth Chapter 10 Saving, Capital Accumulation, and Output Chapter 11 Technological Progress and Growth Chapter 12 Technological Progress: The Short, the Medium, and the Long Run Chapter 13 EXPECTATIONS THE OPEN ECONOMY Expectations: The Basic Tools Chapter 14 Financial Markets and Expectations Chapter 15 Expectations, Consumption, and Investment Chapter 16 Expectations, Output, and Policy Chapter 17 EXTENSIONS Openness in Goods and Financial Markets Chapter 18 The Goods Market in an Open Economy Chapter 19 Output, the Interest Rate, and the Exchange Rate Chapter 20 Exchange Rate Regimes Chapter 21 BACK TO POLICY Should Policy Makers Be Restrained? Chapter 22 Fiscal Policy: A Summing Up Chapter 23 Monetary Policy: A Summing Up Chapter 24 EPILOGUE The Story of Macroeconomics Chapter 25 This page intentionally left blank Sixth Edition MACROECONOMICS Olivier Blanchard International Monetary Fund Massachusetts Institute of Technology David R Johnson Wilfrid Laurier University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editor in Chief: Donna Battista AVP/Executive Editor: David Alexander Senior Editorial Project Manager: Lindsey Sloan Executive Marketing Manager: Lori DeShazo Senior Managing Editor: Nancy Fenton Senior Production Project Manager: Nancy Freihofer Senior Manufacturing Buyer: Carol Melville Cover Designer: Jonathan Boylan Cover Photo: © Alan Z Uster/Fotolia Permissions Specialist: Jill Dougan Image Manager: Rachel Youdelman Executive Media Producer: Melissa Honig MyEconLab Content Lead: Noel Lotz Project Management, Page Makeup, and Design: PreMediaGlobal Printer/Binder: R.R Donnelley / Willard Cover Printer: Lehigh Phoenix Text Font: Utopia 10/12 Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text and on pages C-1–C-3 Copyright © 2013, 2011, 2009 by Pearson Education, Inc., publishing as Prentice Hall All rights reserved Manufactured in the United States of America This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290 Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps Cataloging-in-Publication Data is on file at the Library of Congress 10 ISBN-13: 978-0-13-306163-5 ISBN-10: 0-13-306163-9 To Noelle and Susan About the Authors Olivier Blanchard is the Robert M Solow Professor of Economics at the Massachusetts Institute of Technology He did his undergraduate work in France and received a Ph.D in economics from MIT in 1977 He taught at Harvard from 1977 to 1982 and has taught at MIT since 1983 He has frequently received the award for best teacher in the department of economics He is currently on leave from MIT and serves as the Chief Economist at the International Monetary Fund He has done research on many macroeconomic issues, including the effects of fiscal policy, the role of expectations, price rigidities, speculative bubbles, unemployment in Western Europe, transition in Eastern Europe, the role of labor market institutions, and the various aspects of the current crisis He has done work for many governments and many international organizations, including the World Bank, the IMF, the OECD, the EU Commission, and the EBRD He has published over 150 articles and edited or written over 20 books, including Lectures on Macroeconomics with Stanley Fischer He is a research associate of the National Bureau of Economic Research, a fellow of the Econometric Society, a member of the American Academy of Arts and Sciences, and a past Vice President of the American Economic Association He currently lives in Washington, D.C with his wife, Noelle He has three daughters: Marie, Serena, and Giulia David Johnson is Professor of Economics at Wilfrid Laurier University and Education Policy Scholar at the C D Howe Institute Professor Johnson’s areas of specialty are macroeconomics, international finance, and, more recently, the economics of education His published work in macroeconomics includes studies of Canada’s international debt, the influence of American interest rates on Canadian interest rates, and the determination of the exchange rate between Canada and the United States His 2005 book Signposts of Success, a comprehensive analysis of elementary school test scores in Ontario, was selected as a finalist in 2006 for both the Donner Prize and the Purvis Prize He has also written extensively on inflation targets as part of monetary policy in Canada and around the world His primary teaching area is macroeconomics He is coauthor with Olivier Blanchard of Macroeconomics (fourth Canadian edition) Professor Johnson received his undergraduate degree from the University of Toronto, his Master’s degree from the University of Western Ontario, and his Ph.D in 1983 from Harvard University, where Olivier Blanchard served as one of his supervisors He has worked at the Bank of Canada and visited at the National Bureau of Economic Research, Cambridge University, and most recently at the University of California, Santa Barbara as Canada-U.S Fulbright Scholar and Visiting Chair Professor Johnson lives in Waterloo, Ontario, with his wife Susan, who is also an economics professor They have shared the raising of two children, Sarah and Daniel When not studying or teaching economics, David plays Oldtimers’ Hockey and enjoys cross-country skiing in the winter and sculling in the summer For a complete change of pace, Professor Johnson has been heavily involved in the Logos program, an after-school program for children and youth at First Mennonite Church in Kitchener, Ontario iv Brief Contents THE CORE EXTENSIONS Introduction  1 Expectations  289 Chapter Chapter A Tour of the World  3 A Tour of the Book  19 The Short Run  41 Chapter Chapter Chapter The Goods Market  43 Financial Markets  63 Goods and Financial Markets: The IS–LM Model  85 Chapter 14 Chapter 15 Chapter 16 Chapter 17 The Open Economy  377 Chapter 18 The Medium Run  109 Chapter Chapter Chapter Chapter The Labor Market  111 Putting All Markets Together: The AS–AD Model  133 The Phillips Curve, the Natural Rate of Unemployment, and Inflation  161 The Crisis  183 Chapter 19 Chapter 20 Chapter 21 The Long Run  205 Chapter 11 Chapter 12 Chapter 13 The Facts of Growth  207 Saving, Capital Accumulation, and Output  225 Technological Progress and Growth  249 Technological Progress: The Short, the Medium, and the Long Run  267 Openness in Goods and Financial Markets  379 The Goods Market in an Open Economy  399 Output, the Interest Rate, and the Exchange Rate  423 Exchange Rate Regimes  445 Back to Policy  471 Chapter 22 Chapter 10 Expectations: The Basic Tools  291 Financial Markets and Expectations  313 Expectations, Consumption, and Investment  337 Expectations, Output, and Policy  357 Chapter 23 Chapter 24 Chapter 25 Should Policymakers Be Restrained?  473 Fiscal Policy: A Summing Up  493 Monetary Policy: A Summing Up  517 Epilogue: The Story of Macroeconomics  539 v Contents Preface xiii THE CORE The Short Run 41 Introduction Chapter Chapter 3-1 The Composition of GDP 44 3-2 The Demand for Goods 45 A Tour of the World 1-1 The Crisis 1-2 The United States Consumption (C) 46 • Investment ( I ) 48 • Government Spending (G) 48 Should You Worry about the United States Deficit? 3-3 The Determination of Equilibrium Output 49 1-3 The Euro Area Using Algebra 50 • Using a Graph 51 •  Using Words 53 • How Long Does It Take for Output to Adjust? 54 How Can European Unemployment Be Reduced? 10 • What Has the Euro Done for Its Members? 12 3-4 Investment Equals Saving: An Alternative Way of Thinking about Goods—Market Equilibrium 56 3-5 Is the Government Omnipotent? A Warning 59 1-4 China 13 1-5 Looking Ahead 15 Appendix: Where to Find the Numbers 17 Chapter A Tour of the Book 19 2-1 Aggregate Output 20 GDP: Production and Income 20 • Nominal and Real GDP 22 • GDP: Level versus Growth Rate 24 2-2 The Unemployment Rate 25 Why Do Economists Care about Unemployment? 27 2-3 The Inflation Rate 28 The GDP Deflator 29 • The Consumer Price Index 29 • Why Do Economists Care about Inflation? 30 2-4 Output, Unemployment, and the Inflation Rate: Okun’s Law and the Phillips Curve 31 Okun’s Law 31 • The Phillips Curve 32 2-5 The Short Run, the Medium Run, the Long Run 33 2-6 A Tour of the Book 34 The Core 35 • Extensions 35 • Back to Policy 36 • Epilogue 36 Appendix: The Construction of Real GDP, and Chain-Type Indexes 39 vi The Goods Market 43 Chapter Financial Markets 63 4-1 The Demand for Money 64 Deriving the Demand for Money 66 4-2 Determining the Interest Rate: I 67 Money Demand, Money Supply, and the Equilibrium Interest Rate 68 • Monetary Policy and Open Market Operations 70 • Choosing Money or Choosing the Interest Rate? 72 • Money, Bonds, and Other Assets 72 4-3 Determining the Interest Rate: II 73 What Banks Do 73 • The Supply and the Demand for Central Bank Money 74 4-4 Two Alternative ways of looking at the Equilibrium 79 The Federal Funds Market and the Federal Funds Rate 79 • The Supply of Money, the Demand for Money, and the Money Multiplier 80 • Understanding the Money Multiplier 80 Chapter Goods and Financial Markets: The IS-LM Model 85 Chapter 5-1 The Goods Market and the IS Relation 86 Putting All Markets Together: The AS–AD Model 133 7-1 Aggregate Supply 134 7-2 Aggregate Demand 136 7-3 Equilibrium in the Short Run and in the Medium Run 139 Investment, Sales, and the Interest Rate 86 • Determining Output 87 •  Deriving the IS Curve 89 • Shifts of the IS Curve 89 Equilibrium in the Short Run 139 • From the Short Run to the Medium Run 140 5-2 Financial Markets and the LM Relation 90 7-4 The Effects of a Monetary Expansion 142 Real Money, Real Income, and the Interest Rate 90 • Deriving the LM Curve 91 • Shifts of the LM Curve 92 The Dynamics of Adjustment 142 •  Going Behind the Scenes 143 • The Neutrality of Money 144 7-5 A Decrease in the Budget Deficit 146 5-3 Putting the IS and the LM Relations Together 93 Deficit Reduction, Output, and the Interest Rate 147 • Budget Deficits, Output, and Investment 148 Fiscal Policy, Activity, and the Interest Rate 94 • Monetary Policy, Activity, and the Interest Rate 96 7-6 An Increase in the Price of Oil 149 5-4 Using a Policy Mix 98 5-5 How Does the IS-LM Model Fit the Facts? 102 Appendix: An Alternative Derivation of the LM Relation as an Interest Rate Rule 107 Effects on the Natural Rate of Unemployment 150 • The Dynamics of Adjustment 151 7-7 Conclusions 154 The Short Run versus the Medium Run 154 • Shocks and Propagation Mechanisms 155 • Where We Go from Here 156 The Medium Run 109 Chapter The Labor Market 111 6-1 A Tour of the Labor Market 112 The Large Flows of Workers 112 6-2 Movements in Unemployment 115 6-3 Wage Determination 117 Bargaining 118 • Efficiency Wages 119 • Wages, Prices, and Unemployment 120 • The Expected Price Level 120 • The Unemployment Rate 121 • The Other Factors 121 6-4 Price Determination 122 6-5 The Natural Rate of Unemployment 122 Chapter The Phillips Curve, the Natural Rate of Unemployment, and Inflation 161 8-1 Inflation, Expected Inflation, and Unemployment 162 8-2 The Phillips Curve 164 The Early Incarnation 164 •  Mutations 164 • The Phillips Curve and the Natural Rate of Unemployment 169 • The Neutrality of Money, Revisited 171 8-3 A Summary and Many Warnings 171 Variations in the Natural Rate across Countries 172 • Variations in the Natural Rate over Time 172 • Disinflation, Credibility, and Unemployment 172 •  High Inflation and the Phillips Curve Relation 177 • Deflation and the Phillips Curve Relation 178 The Wage-Setting Relation 123 •  The Price–Setting Relation 123 •  Equilibrium Real Wages and Unemployment 124 • From Unemployment to Employment 125 •  From Employment to Output 126 6-6 Where We Go from Here 127 Appendix: Wage- and Price-Setting Relations versus Labor Supply and Labor Demand 131 Appendix: From the Aggregate Supply Relation to a Relation between Inflation, Expected Inflation, and Unemployment 182 Contents vii equilibrium, 73–81 exchange rates and, 393–395, 442–443, 457–458 fiscal policy and, 94–96 German unification and, 438 investment dependent on, 86–87 LM relation, 107–108 monetary policy and, 96–98 money growth and inflation in relation to, 298–304 money supply and, 72 nominal vs real, 292–295, 308–309 real, 468–469, 523 real money, real income and, 90–91 relationship to investment, 86 rules, 517, 529–530 wealth in money vs bonds, 65 zero, 308 Intermediate good, 20–21 International Monetary Fund (IMF), 18 Internet resources, macroeconomic data, 17–18 Inventories, changes in business, A4 Inventory profit and sales, 350–352 relationship to interest rates, 86 saving and trade balance and, 415, 418 stock market and, 347–348 in United States during WWII, 505 volatility, 352–353 Inventory investment, 45 Investment, 44, 48, 65, 344–352, 541 budget deficits and, 148–149 capital accumulation and, 227–229 China, 15 consumption decisions and, 352–353, 358 current vs expected profit, 348–350 decisions, 346 deficit reduction and, 97 dependent on sales, 86 determinants of, 400–401 equaling saving, 58 goods market, 86–87 nominal, 66 savings and current account balance, 415, 418 stock market, 347–348 Ireland deficit reduction in, 370–371 unemployment, 173–174 unemployment rate (figure), 174 IS curve deriving, 88, 89 expectations and, 360–361 shifts of, 88–90 tax increase effect, 94–96 IS-LM model, 34, 85, 93–98, 541 dynamics, 102–104 liquidity trap, 195 (figure) monetary expansion, 143–144 open economy, 431 in open economy, 432 (figure) real and nominal interest rates, 298 Israel, 462 IS relation aggregate demand, 137–138 expectations and, 358–361 goods market and, 57, 86–90 LM relations and, 93–98 in open economy, 400–403 IS-UM model fiscal policy and interest rate, 94–96 monetary policy and activity, 96–98 Italy bond spreads, 508–509 unemployment rate (figure), 174 J Japan collective bargaining, 118 fiscal policy and liquidity trap, 197 output per person since 1950, 211 (table) output per worker and technological progress, 260 (table) J-curve, 413–414 Job destruction, 278 Jorgenson, Dale, 541 Junior securities, 187 Junk bonds, 315 K Kenya, property rights in, 281 Keynes, John Maynard, 56, 85, 451, 452, 540, 542–543 Keynesians, 542 new Keynesians, 548 Klein, Lawrence, 541–542 Korea, 200 Krugman, Paul, 232 Kuwait, GDP vs GNP example, 392 Kuznets, Simon, 20 Kydland, Finn, 479, 545 L Labor, decreasing returns to, 219 Labor-demand relation, 134 Labor force, 112 unemployment rate and, 25–28 Labor income, 21 Labor in efficiency units, 251 Labor market general considerations, 111–115 institutions, 12 rigidities in, 12, 172 wage- and price-setting, 131–132 Labor productivity, 122 Labor-supply relation, 131–132 Lamont, Owen, 350 Latin America hyperinflation in, 511 nominal interest rates and inflation across, 303 Layoffs, 113 costs of, 173 Lehman Brothers, 4, 55–56 Lerner, Abba, 410 Level of transactions, 64 Leverage ratio, 186 Libor rate, 189 Life cycle theory of consumption, 338 Linear relation, 47 Liquidity, 68, 187–189 Liquidity facilities, 191 Liquidity preference, 540 Liquidity trap, 194, 197, 199 bond yield curve, 322 economic crisis, 530–532 quantitative easing and expectations, 365–366 Litterman, Robert, 476 LM curve deriving, 91–92 equilibrium in financial markets, 137 shifts of, 92 tax increase effect, 94–96 LM relation, 68 aggregate demand, 137–138 expectations and, 361–362 financial markets and, 90–98 interest rate rule, 107–108 Loans, 74, 75 maximum loan-to-value (LTV) ratios, 534 Logarithmic scales, 207, A10–A12 Long run, 33–34 Lucas, Robert, 176, 244, 367, 544–545, 547, 549 Lucas critique, 176, 544 Luxembourg, 174 M M1, 64, 526 M2, 527–528 Maastricht Treaty, 461, 486–487 Macroeconometric models, 476, 541–542 Macroeconomic policy coordination, 408 expectations and, 478–482 politics and, 482–488 Macroeconomic policy makers games they play, 483–485 knowledge base, 474–476 restraints on, 477–478, 482 uncertainty and, 477–478 Macroeconomics new classical economics, 547 new growth theory, 549 new Keynesians, 547 real business cycle theory, 547 Macro prudential regulation, 532–535 Maddison, Angus, 18 Malthus, Robert, 215 Malthusian trap, 215 Mankiw, N Gregory, 548 Mao Tse Tung, 284 Marginal propensity to consume, 47 Market economy, 14 Markup, 122 Marshall, Alfred, 410 Marshall-Lerner condition, 410, 421–422 Maturity, bond, 314 Mavrody, Sergei, 331 McKibbin, Warwick, 476 Medicaid, 508 Medicare, 508 Medium run, 33–34 equilibrium, 140–142, 154–155 flexible vs fixed exchange rates, 446–451 nominal and real interest rates, 300–301 Menem, Carlos, 463 Menu cost, 548 Mexico depreciation of peso in 1990s, 411 output after banking crisis, 200 Index I-5 Mid-cycle deficit, 503 Minimum wages, 173 MMM pyramid, 331 Models of endogenous growth, 244 Modified Phillips curve, 168 Modigliani, Franco, 338, 478, 541 Monetarists, 542–543 Monetary aggregates, 527 Monetary base, 80 Monetary contraction, 96 in United States, 434–435 Monetary expansion, 96, 142–144 IS-LM model, 143–144 response of output to, 475 (figure) stock market and, 326–327 Monetary-fiscal policy mix, 98, 102 A Monetary History of the United States (Friedman and Schwartz), 542 Monetary policy challenges of economic crisis, 530–535 design of, 524–530 dynamics of adjustment, 142–143 effects on, 362–366, 433 expansionary, 142–144 expectations and output, 362–366 fiscal policy vs., 542 interest rate and, 96–98 limits and liquidity trap, 192–196 neutrality of money, 144 in open economy, 433 Monetary policy (continued) open market operations and, 70–72 short-run and medium-run effects, 154–155 Monetary tightening, 96 Money, 65 See also Central Bank money bonds vs., 425 demand for, 64–67, 541 finance, 510–512 growth, 298–304, 525–526 growth, inflation, and interest rates, 298–304 high-powered, 80 long-lasting effects of, 145 multiplier, 80–81 neutrality of, 144, 171 real, 90–91 supply, 68–70, 74–76, 80 Money illusion, 521, 522, 524 Money market funds, 65 Mortensen, Dale, 548 Mortgage-based security (MBS), 187 Mortgage lenders, 184 Mortgages, subprime, 184–185 MPS model, 542 Multilateral exchange rates, 387–388 Multilateral real U.S exchange rate, 387 Multiplicative uncertainty, 477 Multiplier in algebraic equations, 50 money, 80–81 Mundell, Robert, 423, 433, 459–460 Mundell-Fleming model, 423 N Narrow banking, 75 Nash, John, 478 National accounts See National income and product accounts (NIPA) National Basketball Association, 485 I-6 Index National Bureau of Economic Research (NBER), 99 National Economic Trends, 17 National Income and Product Accounts (NIPA), 20, 542 National income and product accounts (NIPA), A1–A6 National Income and Product Accounts of the United States, 17 Natural level of employment, 125–126 Natural level of output, 126–127 Natural rate of unemployment across countries, 170 from employment to output, 126–127 equilibrium real wages and unemployment, 124–125 oil prices and, 150–151 Phillips curve and, 169–170 price-setting relation, 123–124 productivity and, 273–276 from unemployment to employment, 125–126 United States, 175 variations over time, 172, 175 wage-setting relation, 123 Natural real interest rate, 300 Negotiation, hostage taking and, 479 Neoclassical synthesis, 540–543 Net capital flows, 390 Net exports, 45 Net exports, A4 Netherlands, the, 173–174 Net interest, A2 Net national product (NNP), A2 Net transfers received, 390 Neutrality of money, 144, 171 New classical economics, 547 New growth theory, 549–550 New Keynesian economics, 548 News articles, stock market and, 329 New Zealand, 501 Nikkei Index, 330 Nominal exchange rates, 382–387 Nominal GDP, 22–24, 29 Nominal income, 66 Nominal interest rates, 292–295, 308–309, 311–312 expected present discounted value, 311–312 inflation, 303 IS-LM model, 297 medium run, 300–301 short run, 298–300 Nominal rigidities, 548 Non-accelerating, inflation rate of unemployment (NAIRU), 170 Nondurable goods, A3 Nonhuman wealth, 338 Noninstitutional civilian population, 112 Nonresidential investment, 44 Nonresidential investment, A3 North American Free Trade Agreement (NAFTA), 379 North Korea, institutions in, 283 Not in the labor force designation, 26 n-year interest rate, 318 Oil prices, changes in, 149–154 Okun, Arthur, 31 Okun’s law, 31–32 Open economy fiscal policy in, 431–433 IS-LM model in, 432 (figure) IS relation, 400–403 monetary policy effects, 433 Open market operations, 70 aggregate demand and, 138–139 monetary policy and, 70–72 Openness factor markets, 379 financial markets, 379, 388–395 goods markets, 379, 380–388 Optimal control theory, 478, 545 Optimal currency area, 459–460 Ordinary least squares (OLS), A14 Organization chart, book, 34–36 Organization for Economic Co-operation and Development (OECD), 17–18 growth, 215–217 inflation rates in, 519–520, 520 (table) ratio of exports to GDP, 381 Organization of Petroleum Exporting Countries (OPEC), 150 Out of the labor force, 112 Output, 7, See also aggregate output; equilibrium output adjustment over time, 139–142 banking crises, 200 budget deficits and, 148–149 capital, 226–227, 243–244, 252–255 China, 13–14, 14 (table) deficit reduction and, 147–148, 367–369 depreciation and trade balance, 409–412 determining, 87–89 dynamics, 54 dynamics, and IS-LM model, 102–104 expansion, 370–371 fluctuations in, 155 GDP and, 20–21 growth worldwide since 2000 (table), interest rate increase effect, 87–89 investment and, 227–228 monetary policy and expectations and, 362–366 money effects on, 142–143 natural level of, 126–127 productivity and unemployment and, 268–271 savings rate and, 231–235, 238–242 steady state, 231, 238–239 steady-state effect on, 238–239 unemployment and, 268–271 Output growth, Output per hour worked, 211 Output per person, 208–211 across countries, 215–217 across millenia, 215 convergence of, 214–215 OECD countries, 215–217 rich countries, 211, 213–215 Output per worker, 211, 219–220 O P OECD Economic Outlook, 18 OECD Employment Outlook, 18 Panel data sets, 339 Panel Study of Income Dynamics (PSID), 339 Paradox of saving, 59 Parameters, 47 Participation rate, 27, 112 Patents, 259 Pay-as-you-go system, 236–237 PAYGO rule, 486, 488 Payments balance of, 389–391 constant interest rates and, 308 Pegging of currency, 435–437 exchange rate, 435–437 hard, 462 Pent-up demand, 199 Permanent income theory of consumption, 338 Perry, Rick, 473 Personal consumption expenditures, A3 Personal disposable income, A3 Personal income, A3 Phelps, Edmund, 125, 169, 170, 543 Phillips, A W., 161 Phillips curve, 32–33, 161–162, 164–171, 542–543 deflation and, 178–179 Friedman’s critique, 170 high inflation, 177–178 mutations, 166–168 natural rate of unemployment and, 169–170 rational expectations and, 544–545 wage-price spiral, 164 Physical capital, 242–244 endogenous growth, 244 extending production function, 242–243 output and, 243–244 Pissarides, Christopher, 548 Players, 478 Poland, hyperinflation in, 512 (table) Policy expectations, 478–482 financial crisis use and limits, 189–196 mix of, 473 politics, 482–485, 487–488 role of, 543 theory of, 546 uncertainty, 474–478 Policy coordination, 408 Policy mix Clinton-Greenspan, 102 monetary-fiscal, 98, 102 Political business cycle, 483 Politics, macroeconomic policy and, 482–488 Portugal, 174, 455 PPI See producer price index PPP See purchasing power parity (PPP) Prescott, Edward, 479, 545, 547 Present value, 306–308 bonds prices as, 315–316 deriving, 311–312 expected profits, 345–346, 356 nominal vs real interest rates and, 308–309 stock prices as, 323–325 utilization of, 304–309 Price, housing, 184 Price determination, production function, 122 Price indexes, 29–30 Price level, 29 expected, 120–121 Prices, wages, unemployment and, 120 Price-setting relation, 123–124, 134, 272–273 Primary deficit, 497 Primary surplus, 497 Prison population, 175 Private saving, 57 Private sector involvement, 509 Private spending, 359 Production, 30, 43 See also output Production function, 122 aggregate, 217–218 Cobb-Douglas, 247 extending, 242–243 price determination, 122 technological progress and, 250–252 Productivity natural rate of unemployment and, 272–276 output and unemployment and, 268–271 Product side, national accounts, A3–A4 Profit corporate, A2 current vs expected, 348–350 expectations and investment, 344–346 expected present value under static expectations, 356 sales and, 350–352 Profitability, cash flow vs., 350 Profit income, 21 Propagation mechanism, of shocks, 155––156 Propensity to consume, 47 Propensity to save, 58 Property rights, protection of, 281–284 Proprietor’s income, A2 Public saving, 57 Purchasing power parity (PPP), 13, 209 construction of, 210 Pure inflation, 30–31 Q Quantitative easing, 196, 365–366, 531 Quits, 113 Quotas, 379 R Random walk, 326 Random walk of consumption, 546 Random walk of stock prices, 326 Rating agencies, 187 Rational expectations, 366, 367 critique of, 543–546 integration of, 545–546 Phillips curve and, 544–545 Rational speculative bubbles, 331–333 Real appreciation, 385 Real business cycle theory, 547 Real depreciation, 385 Real exchange rate, 382, 383–387, 468–469 Real GDP, 22–24, 29 computing, 23, 25 construction of, 39–40 Real GDP in chained (2005) dollars, 23 Real GDP per capita, 24 Real income, 90–91 Real interest rates, 292–295, 298–304, 308–309, 311–312, 468–469 expected present discounted value, 311 IS-LM model, 297 medium run, 300–301 negative, 523 real exchange rate and, 468–469 short run, 298–300 Real money, 90–91 changes in stock, 137 Real wages, 31 equilibrium, 124–125 natural rate of unemployment and, 273–274 receipts of factor income from the rest of the world, A2 Recession, 24–25 Euro market members, 12 shocks and, 155–156 United States, 99–101 Reform, Social Security, 236–237 Regression, A14 Regression line, 168 Regression line, A14 Relative price, 23 Rental cost, 348 Rental income of persons, A2 Repayment, debt, 497–499 Research and development (R&D), 256–257 Research process, 256–257 appropriability of results, 258–260 fertility of, 257–258 Reservation wage, 118 Reserve ratio, 74 Reserves, 73 demand for, 77 Residential investment, 44 Residential investment, A3 Residual, 265–266 Residual, A14 Retail sales, 352 Retirement saving, 342 Returns to capital, decreasing, 219 Returns to factors, 218–219 Returns to labor, decreasing, 219 Returns to scale, constant, 218–219 Revaluations, 383 Ricardian equivalence, 502–503 Ricardo, David, 502 Ricardo-Barro proposition, 502 Risk, default, 314, 506 Risk, stock prices and, 328–330 Risk averse, 328 Risk neutral, 328 Risk premium, 315 Romer, Paul, 244, 549 Roubini, Nouriel, 18 Russia hyperinflation, 512 (table) MMM pyramid, 331 U.S currency, holders of, 67 S Sachs, Jeffrey, 476 Sales investment dependent on, 86 profit and, 350–352 Samuelson, Paul, 161, 540 Sargent, Thomas, 176, 367, 544 Index I-7 Saving, 65 investment and trade balance and, 415, 418 investment equaling, 57 paradox of, 59 private, 57 public, 57 retirement, 342 Social Security and, 236–237 U.S current account deficit, 416–418 Saving rate, 220, 225 consumption and, 235, 237–238 dynamics of capital and output, 229–232 effect on steady-state output, 238–239, 255–256 increase, dynamic effects of, 239–241 output in relation to, 231–235, 238–242 steady state, 231, 238–239 United States, 236–237, 241–242 Schelling, Tom, 478 Schumpeter, Joseph, 276, 549 Schwartz, Anna, 542 Securitization, 186–187 Seignorage, 510–511, 522–523 Selten, Reinhard, 478 Senior securities, 187 Separations, 113 Services, A3 Shadow banking system, 188 Shadow cost, 348 Shafir, Eldar, 522 Shares, 323 Shiller, Robert, 332–333 Shleifer, Andrei, 549, 550–551 Shocks to aggregate supply, 155–156 labor market, 173 Shoe-leather costs, 520 Short run, 33–34 aggregate demand, 448–450 equilibrium, 139–140, 154–155 nominal and real interest rates, 531–532 Sims, Christopher, 476 Skill-biased technological progress, 280 Social Security, 236–237 Soft landing, 319–320 Solow, Robert, 161, 217, 265, 541 Solow residual, 265–266 Solvency, 186, 188–189 South Korea, institutions in, 283 Soviet Union, 232 Spain bond spreads, 508–509 EMS crisis, 455 unemployment rate (figure), 174 unemployment rate in 1994, 28 Spending aggregate private, 359 autonomous, 50 Spending caps, 488 Spread, 508 Stagflation, 153, 543 Staggering of wage and price decisions, 546 Stalinist growth, 232 Standardized employment deficit, 503 Standard of living, 208–211 increase in since 1950, 213–214 Standard & Poor’s Index, 315, 323 Starve the Beast, 484 State of technology, 218, 250 I-8 Index Static expectations, 346, 356 Statistical Abstract of the United States, 17 Statistical discrepancy, 390 Steady state capital, 231 Cobb-Douglas production function and, 247 Stock indexes, 323 Stock market economic activity and, 325–326 increase in consumer spending and, 327–328 investment and, 347–348 monetary expansion and, 326–327 Stock prices from 2007-2010, bubbles and fads, 328–331 movements in, 322–328 as present values, 323–325 Stocks, 323 Stone, Richard, 20 Strategic interactions, 478 Strauss-Kahn, Dominique, 409 Structural change, 276 Structural deficit, 503 Structural rate of unemployment, 125 Structured investment vehicle (SIV), 188 Structures, A3 Subprime mortgages, 184 Supply See Aggregate supply Surpluses budget, 57 capital account, 390 Survey of Current Business, 17 Survey of Income and Program Participation, 342 Sweden, 174, 200, 455 Technology corn hybridization, 258 output in relation to, 218 state of, 218, 250 Ted spread, 189 Temporary help, 175 Term structure of interest rates, 314 Thailand, 200 Thaler, Richard, 551 Time consistency, 482 Time inconsistency, 479, 545 Tirole, Jean, 550 Tobin, James, 346, 347–348, 541 Tobin’s q, 347–348 Total wealth, 338 Toxic assets, 187 Tradable goods, 381 Trade balance, 45 depreciation and output and, 409–412 equilibrium output and, 403–404 saving and investment and, 415, 418 wage inequality, increasing, 280 Trade balance, A4 Trade deficit, 45, 405 United States, 416–418 Trade surplus, 45 Transfers, business, A2 Treasury bills (T-bills), 71, 315 inflation, 304 (figure) Treasury bonds, 315 Treasury notes, 315 Troubled Asset Relief Program (TARP), 191 Trust fund, 236 Tulipmania, 331 Tversky, Amos, 522 2001 recession, 99–101 T U Tariffs, 379 Tax distortions, 505–506, 520–521 Taxes, 48 current vs future, 497–501 effect on IS curve, 88, 94–96 government control of output, 58–59 indirect, A2 in national income accounts, A5 Taylor, John, 145, 476, 528, 546 Taylor model, disinflation, 145 Taylor rule, 529–530 Tea Party, 473 Technological catch-up, 262 Technological frontier, 262 Technological progress aggregate supply and demand and, 268–271 capital accumulation vs., 260–262 constructing measure of, 265–266 determinants, 256–260 diffusion, 258 distribution effects, 276–281 growth, 220, 249 institutions, 281–284 output and capital, 252–255 production function and, 250–252 real business cycle models and, 547 real GDP and changes in market, 25 savings rate, 255–256 skill-biased, 280 Technological unemployment, 272 Uncovered interest parity, 393 Underwater, 185 Unemployment, 25 disinflation and, 172, 174 duration, 114 economists’ view of, 27–28 equilibrium real wages and, 124–125 in Europe, 173–174 inflation and, 182, 479–480 insurance, 121 job destruction, churning, and earnings losses, 278 movements in, 115–117 output and, 268–271 relation to inflation and expected inflation, 182 technological, 272 wages and prices and, 120 Unemployment rate, 7, 25–28, 112, 121 See also natural rate of unemployment computing, 26 equilibrium, 125–126 labor force and, 26–27 natural, 122–127 1994-2010, 116 (figure) in Spain, 28 structural, 124–125 U.S., 1960-2010 (figure), 27 versus output growth in U.S., 1960-2010 (figure), 32 wages and, 120 United Kingdom debt ratios after WWII, 501 gold standard, 452 nominal and real interest rates, 395 (figure) output per person since 1950, 211 (table) output per worker and technological progress, 260 (table) unemployment, 173–174 unemployment rate (figure), 174 United States, 6–9 balanced budget, 473 budget deficit, 8–9, 507–508 consumption during WWII, 505 country composition of exports and imports, 2010 (table), 387 currency, holders of, 67 current account deficit, 416–418 deficit reduction in, 487–488 economic statistics, 17 employment, unemployment and nonparticipation rates (1994-2011), 113 (figure) exports to GDP ratios since 1960, 381 (figure) growth, unemployment, inflation 1960– 2007 (table), housing price increases, 332–333 income adjustment from GDP to GNP, A1–A2 inflation in, 152 (figure), 162 (figure), 166–168 inflation rate since 1914, 166 (figure) interest rates since 1978, 294–295 monetary contraction and fiscal expansion, 434–435 natural rate of unemployment, 175 nominal and real interest rates, 294–295, 395 (figure) output per person since 1950, 211 (table) output per worker and technological progress, 260 (table) property rights in, 281 recession of 2001, 99–101 saving rate, 225 Social Security, 236–237 unemployment, 26–27 unemployment rate 1948-2010, 115 (figure) U.S Department of Commerce, 17 User cost, 348 V Value added, GDP as sum of, 21 Variables Variables (continued) endogenous, 48 exogenous, 48 Venti, Steven, 342 Volatility exchange rate, 457–458 investment and consumption, 352–353 Voters, policymakers and, 483–484 W Wage decisions, staggering of, 546 Wage determination, 117–121 bargaining, 118 efficiency wages, 119–120 expected price level, 120 unemployment and prices, 120 unemployment insurance, 121 unemployment rate, 120 Wage indexation, 177–178 Wage inequality, increase in, 279–281 Wage-price spiral, 164 Wages, real, 124–125, 273 Wage-setting relation, 123, 131–132, 273 Wars of attrition, 485 deficits and, 504–506 Wealth, 65 in form of bonds, 64–65 types of, 338 Web sites, for macroeconomic issues, 18 Well-functioning stock market, 326 Wholesale funding, 75, 187 Wise, David, 342 Woodford, Michael, 550 Workers bargaining power, 118 discouraged, 26, 115 flows of, 112–115 output and capital per, 219–220 World Economic Outlook, 18 The World Economy: A Millennial Perspective, 18 Y Yeltsin, Boris, 331, 453 Yield curve, 314 economic activity and, 319–321 interpreting, 319 liquidity trap, 322 Yield to maturity, 314 Z Zero interest rates, 308 Zimbabwe, hyperinflation in, 511 Index I-9 This page intentionally left blank Credits Chapter Chapter p 23: Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St Louis: Series GDPCA,GDPA: U.S Department of Labor: Bureau of Labor Statistics; http://research.stlouisfed.org/fred2/ p 145: MACROECONOMIC POLICY IN A WORLD ECONOMY by John Taylor Copyright © 1993 John Taylor Reprinted by permission of the author p 26: Non Sequitur © 2006 Wiley Ink, Inc Dist by Universal Uclick Reprinted with permission All rights reserved p 27: Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St Louis: Series GDPCA,GDPA: U.S Department of Labor: Bureau of Labor Statistics; http://research.stlouisfed.org/fred2/ Chapter p 43: Toles © 1991 The Washington Post Reprinted with permission of Universal Uclick All rights reserved p 56: Copyright © 2012 Google Inc Reprinted by permission Chapter p.100: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 103: “The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds” by Lawrence J Christiano, Martin Eichenbaum and Charles Evans from THE REVIEW OF ECONOMICS AND STATISTICS, 78:1 Copyright © 1996 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology Chapter p 115: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 119: “Did Henry Ford Pay Efficiency Wages?” by Dan Raff and Lawrence Summers from THE JOURNAL OF LABOR ECONOMICS, 5:4, October 1987 Copyright © 1987 University of Chicago Press Reprinted by permission p 149: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 152: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 154: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission Chapter p 165: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 166: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 168: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 170: “The Role of Monetary Policy,” March 1968, American Economic Review 58-1, 1-17 Copyright © 1968 American Economic Association Reprinted by permission Chapter p 192: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission Chapter 10 p 209: Copyright © 1988 by Dana Fradon/The New Yorker Collection/The Cartoon Bank p 211: SOURCE: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 7.0, Center for C-1 International Comparisons of Production, Income and Prices at the University of Pennsylvania, May 2011 p 214: SOURCE: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 7.0, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, May 2011 p 216: SOURCE: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 7.0, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, May 2011 Chapter 11 p 232: POSTWAR ECONOMIC RECONSTRUCTION AND LESSONS FOR THE EAST TODAY by Rudiger Dornbusch, Wilhelm Nolling, and Richard Layard, eds Copyright © 1993 MIT Press Reprinted by permission Chapter 12 p 296: “Nominal Interest Rates and Inflation: Latin America, 1992-1993” in IMF INTERNATIONAL FINANCIAL STATISTICS Copyright © 2012 International Monetary Fund Reprinted by permission p 304: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission Chapter 15 p 314: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 322: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 323: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 258: “Hybrid Corn: An Exploration in the Economics of Technological Change,” by Zvi Griliches from ECONOMETRICA, October 1957 Copyright © 1957 The Econometric Society Reprinted by permission p 329: © Tribune Media Services, Inc All Rights Reserved Reprinted with permission p 259: © Chappatte in “L’Hebdo”, Lausanne—www globecartoon.com p 340: Cartoon Excerpted by permission from Cartoon Bank Copyright © 1997 by Roz Chast/The New Yorker Collection/The Cartoon Bank Chapter 13 p 271: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 277: © Chappatte in “Die Weltwoche”, Zurich— www.globecartoon.com p 278: “Earnings of Displaced Male Workers before and after Displacement” by Steven J Davis and Till M vonWachter, from BROOKINGS PAPERS ON ECONOMIC ACTIVITY, Fall 2011 Copyright © 2011 Steven J Davis and Till M vonWachter Reprinted by permission p 281: “Understanding Institutions” by Daron Acemoglu from the Lionel Robbins lectures Copyright © 2004 Daron Acemoglu Reprinted by permission p 282: “Understanding Institutions” by Daron Acemoglu from the Lionel Robbins lectures Copyright © 2004 Daron Acemoglu Reprinted by permission Chapter 16 p 344: Surveys of Consumers by Thomson Reuters/ University of Michigan Copyright © 2012 Thomson Reuters/University of Michigan Reprinted by permission p 353: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission Chapter 18 p 380: “Growth in Advanced and Emerging Economies Since 2005” in WORLD ECONOMIC OUTLOOK, July 8, 2009 Copyright © 2009 International Monetary Fund Reprinted by permission Chapter 21 p 445: Copyright © 1971 by Ed Fisher/The New Yorker Collection/The Cartoon Bank Chapter 14 Chapter 23 p 295: Graphs and Charts from FRED, Federal Reserve Bank of St Louis Copyright © 2012 Federal Reserve Bank of St Louis Reprinted by permission p 512: “The Monetary Dynamics of Hyperinflation” by Milton Friedman from STUDIES IN THE QUANTITY THEORY OF MONEY Copyright © 1956 C-2 Credits University of Chicago Press Reprinted by permission of the publisher p 541 (middle): AFP/Newscom Chapter 24 p 546 (middle): Achmad Ibrahim/AP Images p 518: Daryl Cagle/MSNBC.com/Cagle Cartoons p 522: “Money Illusion” by Eldar Shafir, Peter Diamond, and Amos Tversky from the QUARTERLY JOURNAL OF ECONOMICS, 1997 (No 2): 341–374 Copyright © 1997 Oxford University Press Reprinted by permission of the publisher p 542 (bottom): Chuck Nacke/Alamy p 546 (bottom): Michael Probst/AP Images p 547: Giuseppe Aresu/AP Images p 548 (bottom): Jay L Clendenin/Aurora Photos/ Aurora Photos p 551 (bottom): Antoine Devouard/REA/Redux Chapter 25 p 540 (top): Bettmann/Corbis p 541 (top): Plinio Lepri/AP Images Credits C-3 This page intentionally left blank The Pearson Series in Economics Chapman Environmental Economics: Theory, Application, and Policy Hartwick/Olewiler The Economics of Natural Resource Use Cooter/Ulen Law & Economics Heilbroner/Milberg The Making of the Economic Society Downs An Economic Theory of Democracy Heyne/Boettke/Prychitko The Economic Way of Thinking Bierman/Fernandez Game Theory with Economic Applications Ehrenberg/Smith Modern Labor Economics Hoffman/Averett Women and the Economy: Family, Work, and Pay Blanchard Macroeconomics* Farnham Economics for Managers Blau/Ferber/Winkler The Economics of Women, Men and Work Folland/Goodman/Stano The Economics of Health and Health Care Boardman/Greenberg/Vining/ Weimer Cost-Benefit Analysis Fort Sports Economics Hubbard/O’Brien Economics* Money, Banking, and the Financial System* Froyen Macroeconomics Hubbard/O’Brien/Rafferty 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Walters/Walters/Appel/Callahan/ Centanni/Maex/O’Neill Econversations: Today’s Students Discuss Today’s Issues Weil Economic Growth Williamson Macroeconomics This page intentionally left blank Symbols Used in This Book Symbol ( )d e ( ) A a B C CU c c0 c1 D $D d E E Ee e G gA gK gM gN g, gy H I IM i i1 i2 i* K Term Superscript d means demanded Superscript e means expected Aggregate private spending Also: Labor productivity/states of technology Effect on the inflation rate of the unemployment   rate, given expected inflation Goverment debt Consumption Currency Proportion of money held as currency Consumption when disposable income   equals zero Propensity to consume Checkable deposits Also: Real dividend on a stock Nominal dividend on a stock Depreciation rate Nominal exchange rate (price of domestic currency in terms of foreign currency) Fixed nominal exchange rate Expected future exchange rate Real exchange rate Government spending Growth rate of technological progress Growth rate of capital Growth rate of nominal money Growth rate of population Growth rate of output High powered money/monetary base/   central bank money Also: Human capital Fixed investment Imports Nominal interest rate One-year nominal interest rate Two-year nominal interest rate Foreign nominal interest rate Also: Target interest rate for central bank Capital stock Introduced in Chapter 17 6, 12 23 4 3 15 15 11 18 20 18 18 12 12 12 11 3 15 15 18 10 Symbol L M Md Ms m N Nn NI NX P P* p Π Q $Q R r S s T Tr u U u un V $V W Y $Y YD YL Yn Y* X Z z $Z Term Labor force Money stock (nominal) Money demand (nominal) Money supply (nominal) Markup of prices over wages Employment Natural level of employment Net income payments from the rest of the world Net exports GDP deflator/CPI/price level Foreign price level Inflation Profit per unit of capital Real stock price Nominal stock price Bank reserves Real interest rate Private saving Private saving rate Net taxes (taxes paid by consumers minus   transfers) Government transfers Reserve ratio of banks Unemployment Unemployment rate Natural rate of unemployment Present value of a sequence of real payments z Present value of a sequence of nominal payments $z Nominal wage Real GDP/Output/Production Nominal GDP Disposable income Labor income Natural level of output Foreign output Exports Demand for goods Factors that affect the wage, given unemployment Also: A real payment Nominal payment Introduced in Chapter 4 6 19 18 16 15 15 14 11 23 2 14 14 2 16 19 3 14 14