Advanced macroeconomics (4e david romer)

This page intentionally left blank ADVANCED MACROECONOMICS Fourth Edition i The McGraw-Hill Series in Economics ESSENTIALS OF ECONOMICS Brue, McConnell, and Flynn Essentials of Economics Second Edition Slavin Economics, Microeconomics, and Macroeconomics Tenth Edition MONEY AND BANKING Cecchetti and Schoenholtz Money, Banking, and Financial Markets Third Edition Mandel Economics: The Basics First Edition ECONOMICS OF SOCIAL ISSUES Guell Issues in Economics Today Fifth Edition URBAN ECONOMICS O’Sullivan Urban Economics Seventh Edition Sharp, Register, and Grimes Economics of Social Issues Nineteenth Edition LABOR ECONOMICS Borjas Labor Economics Fifth Edition Schiller Essentials of Economics Eighth Edition PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, and Macroeconomics Eighth Edition Frank and Bernanke Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Fourth Edition Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Second Edition McConnell, Brue, and Flynn Economics, Microeconomics, Macroeconomics Nineteenth Edition McConnell, Brue, and Flynn Brief Editions: Microeconomics and Macroeconomics First Edition Miller Principles of Microeconomics First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Nineteenth Edition Schiller The Economy Today, The Micro Economy Today, and The Macro Economy Today Twelfth Edition ECONOMETRICS Gujarati and Porter Basic Econometrics Fifth Edition Gujarati and Porter Essentials of Econometrics Fourth Edition MANAGERIAL ECONOMICS Baye Managerial Economics and Business Strategy Eighth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Fifth Edition Thomas and Maurice Managerial Economics Tenth Edition INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics First Edition Dornbusch, Fischer, and Startz Macroeconomics Eleventh Edition Frank Microeconomics and Behavior Eighth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Fourth Edition ii McConnell, Brue, and Macpherson Contemporary Labor Economics Ninth Edition PUBLIC FINANCE Rosen and Gayer Public Finance Ninth Edition Seidman Public Finance First Edition ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Fifth Edition INTERNATIONAL ECONOMICS Appleyard, Field, and Cobb International Economics Seventh Edition King and King International Economics, Globalization, and Policy: A Reader Fifth Edition Pugel International Economics Fourteenth Edition ADVANCED MACROECONOMICS Fourth Edition David Romer University of California, Berkeley iii Romer-1820130 rom11374˙fm˙i-xx February 17, 2011 8:12 iv ADVANCED MACROECONOMICS, FOURTH EDITION Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020 Copyright c 2012 by The McGraw-Hill Companies, Inc All rights reserved Previous editions c 2006, 2001, and 1996 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper DOC/DOC ISBN 978-0-07-351137-5 MHID 0-07-351137-4 Vice President & Editor-in-Chief: Brent Gordon Vice President EDP/Central Publishing Services: Kimberly Meriwether David Publisher: Douglas Reiner Marketing Manager: Dean Karampelas Managing Developmental Editor: Christina Kouvelis Editorial Coordinator: Alyssa Otterness Project Manager: Robin A Reed Design Coordinator: Margarite Reynolds Cover Designer: Studio Montage, St Louis, Missouri Buyer: Nicole Baumgartner Media Project Manager: Balaji Sundararaman Compositor: MPS Limited, a Macmillan Company Typeface: 9.25/12 Lucida Bright Printer: R R Donnelley Library of Congress Cataloging-in-Publication Data Romer, David Advanced macroeconomics / David Romer — 4th ed p cm ISBN 978-0-07-351137-5 Macroeconomics I Title HB172.5.R66 2012 339—dc22 2010040893 www.mhhe.com iv To Christy v This page intentionally left blank ABOUT THE AUTHOR David Romer is the Royer Professor in Political Economy at the University of California, Berkeley, where he has been on the faculty since 1988 He is also co-director of the program in Monetary Economics at the National Bureau of Economic Research He received his A.B from Princeton University and his Ph.D from the Massachusetts Institute of Technology He has been on the faculty at Princeton and has been a visiting faculty member at M.I.T and Stanford University At Berkeley, he is a three-time recipient of the Graduate Economic Association’s distinguished teaching and advising awards He is a fellow of the American Academy of Arts and Sciences, a former member of the Executive Committee of the American Economic Association, and co-editor of the Brookings Papers on Economic Activity Most of his recent research focuses on monetary and fiscal policy; this work considers both the effects of policy on the economy and the determinants of policy His other research interests include the foundations of price stickiness, empirical evidence on economic growth, and asset-price volatility He is married to Christina Romer, with whom he frequently collaborates They have three children, Katherine, Paul, and Matthew vii This page intentionally left blank 702 Subject Index Frequency effect, 332 Frequency of price adjustment, 337–339, 352 Frictional unemployment, 493 Full-employment output, 259 Fully endogenous growth models, 116 Fully-funded social security, 98 G Game theory, 289–290 General Theory (Keynes), 245, 246 Geography, and cross-country income differences, 165, 167, 172–178 Global warming, 44–45 Golden-rule capital stock, 23, 62, 65, 88–89, 91 Golden-rule level of education, 155n, 183 Goods market imperfections, 250–253, 268–274 Goods-producer-surplus effect, 132 Government budget constraint, 586–592, 609 Government debt; see Budget deficits; Fiscal policy; Policymakers Government default, 631–638 Government purchases; see also Fiscal policy common-pool spending problem, 627–628, 643 in Diamond model, 92–93 and distortionary taxes, 230, 599–601 and household budget constraint, 72–73, 593–594 predictable movements in, 601–602 with price rigidity, 242, 244 in Ramsey-Cass-Koopmans model, 71–77, 96–97 in real-business-cycle models, 194, 196, 206–207, 209, 215–217 and real interest rates, 75–77 for war, 75–77 Government rent-seeking behavior, 163 Great Depression, 192, 227, 447, 551, 632 Great Inflation, 564–567 Great Moderation, 192, 644 Great reversal, 176 Grossman-Helpman model, 103, 118, 133 Growth accounting, 30–32, 48, 145 Growth disasters and miracles, 7, 182–183 Growth drag, 41–43 Growth effects, 20–21 Growth rate, 14, 19n, 45 H Habit formation, 358, 390n, 402–403 Half-life, 26n Hamiltonian, 413, 454 Harris-Todaro model, 510–511 Harrod-neutral technological progress, 10 Hazard rate, 468 Health care costs, 584, 590–592 Hedging of risks, 385 Hicks-neutral technological progress, 10n, 13n Hierarchical institutions, 627–628 High-powered money, 302n, 523, 524, 550, 568 Hodrick-Prescott filter, 218n Home bias, 386 Horse-race regressions, 305–306 Households; see also Consumption; Labor supply in baseline price rigidity model, 240–242 in Diamond model, 78–81 entry into economy, 50, 595–596 forward-looking behavior of, 66, 75 in imperfect competition model, 270–271 infinitely lived, 49, 126, 195, 315–316 in Ramsey-Cass-Koopmans model, 50–57 in real-business-cycle models, 197–201 in Romer model, 126–129, 130n Housing market, 191, 453, 644–645, 646 Human capital and cross-country income differences, 156–160, 180 and increasing returns, 186 physical capital effects on, 159n vs raw labor, 152 in Solow model, 151–156, 185 sources of variation in, 159–160 Hybrid Phillips curve, 261, 341–343 Hyperinflation, 518, 567–568, 572–576, 607, 617–618 Hysteresis, 484–486 I Identity operator, 327 Idiosyncratic risk, 432, 445 Immigrants, and wage differences, 159 Impatience, and consumption, 393, 395, 397–398 Subject Index Imperfect competition; see Competition, imperfect Imperfect information, 282–283, 567n, 605–606; see also Lucas imperfect-information model Implicit contracts, 480–481, 499–501, 509–510 Implicit differentiation, 24n Inada conditions, 12, 16–17 Incentive-compatible contracts, 509 Incentive contracts, for policymakers, 559n Income differences, cross-country, 150–188 and convergence, 32–36, 179–182 growth miracles and disasters, 7, 182–183 and investment choices, 28–29 and knowledge, 29, 32, 143–145, 149 overview of, 7–8, 150–151 and Solow model, 27–30, 151–156 Income effect, 80, 198, 203, 381 Income, permanent vs transitory, 367, 370–371 Incomplete markets, 99–100 Increasing returns to scale; see Returns to scale, increasing Indexation and employment movements, 309–310 lack of, with debt contracts, 301–302 new Keynesian Phillips curve with, 344–347 Indivisible labor, 229–230 Inertia, in deficits, 622–623 Inertia, inflationary, 261, 340–344 Infinite duration, 100 Infinite output, in research and development model, 109n Infinitely lived households, 49, 126, 195, 315–316 Inflation; see also Dynamic inconsistency; Interest-rate rules; Output-inflation tradeoff; Seignorage and aggregate demand shocks, 304–306 in AS-AD diagram, 262–263 and central bank independence, 562–564 core, 259–261 costs of, 523–526 and debt crises, 631 and deficit measurement, 587–588 and delegation, 560–563 dislike of, 525 703 and divine coincidence, 537–538 expected, 259, 261, 296, 357, 572, 577 expected vs actual, 555–558, 568 expected vs core, 261 in Great Inflation, 564–567 inertia in, 261, 340–344 lagged, 344–347, 532 from money growth, 514–518 in new Keynesian Phillips curve, 331 optimal rate of, 527, 528, 531, 556 and output, 298–299, 342 and policymaker reputation, 559–560 potential benefits of, 526–527 potential sources of, 514–515 and price adjustment, 304–306 and real money balances, 514–515 during recessions, 193 variability of, 525–526 Inflation bias, 513–514, 554, 567n Inflation-indexed bonds, 523n Inflation inertia, 261, 340–344 Inflation-output tradeoff; see Output-inflation tradeoff Inflation shocks, 354, 356 Inflation targeting, 223n, 535, 551–552 Inflation-tax Laffer curve, 569–570 Inflation-tax revenues, 569 Information, imperfect; see Imperfect information Information technology, and productivity rebound, 32 Input-output linkages, 282 Insensitivity of profit function, 280–281 Inside the unit circle, 540 Insider-outsider models, 482–486, 510 Instantaneous utility functions for constant-absolute-risk-aversion, 403 quadratic, 372, 374–375, 394–395 in Ramsey-Cass-Koopmans model, 50–51, 54 in real-business-cycle models, 196–197, 218n in Romer model, 126 in Shapiro-Stiglitz model, 468 for simple consumption case, 366 Institutions, 162–164, 170–173, 176–177, 178n Instrumental variables, 165–169, 376–377, 396, 549 Intensive form of production function, 11–13 Interacted variables, 625 Interest factors, 633, 634, 635–637 704 Subject Index Interest-rate rules in canonical new Keynesian model, 353, 356 design of, 544–548 estimation of, 548–550 in exogenous nominal rigidity model, 262, 264 forward-looking, 353, 356, 546 in monetary policy models, 535–536, 538–542 and natural rate of interest, 535, 538–539 in new Keynesian models, 359–360 overview of, 543–544 Interest-rate spreads, 547, 645 Interest-rate targeting, 579 Interest rates central bank control of, 307–308 and consumption, 380–384 and dynamic efficiency, 90–91 and expectations, 519–523 and Federal Reserve policy, 224–226 and investment, 422–423, 428–429, 444–445 in IS curve, 261–263 and labor supply, 199 and lagged inflation, 532 and money growth changes, 515–518 natural, 535–536, 538–539, 545 and new Keynesian IS curve, 241, 242 nominal vs real, 75, 224 in q theory model, 422–423 during recessions, 193 and saving, 380–384 short-term, 422, 518–523 in specific models, 51, 64n, 74, 79–81, 86–87, 129, 532 as tax rate on money balances, 569n and technology shocks, 213–214 term structure of, 518–523, 578–579 and wartime government purchases, 75–77 zero lower bound on nominal, 308, 526–527, 539n, 550–554, 580, 647–648 Intergenerational links, 595–596 Interindustry wage differences, 501–504 Intermediation, 358–359, 447, 647 Internal adjustment costs, 408 Internal habits, 403 Internal vs external financing, 447–451 International aid, 623, 642 International borrowing, 632n Intertemporal elasticity of substitution, 51, 94, 215, 228, 381, 383–384 Intertemporal first-order condition, 210–211 Intertemporal substitution in labor supply, 197–199, 204, 214–215 Intratemporal first-order condition, 208–209 Inventories, 191 Investment, 405–455; see also Financial-market imperfections; q theory model of investment actual vs break-even, 16–17, 18–19, 21–23, 24n, 58–59 and asset pricing, 646–647 and capital income, 91 and cash flow, 447–451 and cost of capital, 405–408 and cross-country income differences, 28–29, 160–161 and financial-market disruptions, 632 and financial-market imperfections, 301–302, 436–451 with fixed adjustment costs, 434–436 and government purchases, 71–72 and inflation, 524, 526 irreversible, 430–432 and kinked adjustment costs, 432–434 and saving rate, 18–19, 36–37 and social infrastructure, 162–163 and stabilization policy, 530 and taxes, 95–96, 426–432, 445, 453 under uncertainty, 428–432, 436, 454 Investment adjustment costs, 408n Investment-output ratio, 160–161 Investment tax credit, 407, 423–425, 452 Irreversible investment, 430–432 IS curve, new Keynesian in canonical new Keynesian model, 352, 353, 356 in new Keynesian models, 316, 357–358 in price rigidity models, 241, 261–262, 264 IS-LM model, 242–244, 262 IS-MP model, 262–263 Subject Index J Job breakup rate, 468, 487, 493 Job creation and destruction, 494 Job-finding rate, 489, 490, 491 Job selling, 477–478 K k-percent rule, 543 Keeping up with the Joneses, 368 Keynesian consumption function, 368–369 Keynesian models, 245–246, 368–369; see also Dynamic new Keynesian models Kinked adjustment costs, 432–434, 436 Knowledge; see also Research and development lags in diffusion of, 32, 144, 149 production function for, 103 in real-business-cycle models, 197 in Solow model, 10, 13–14, 27, 29, 152 Knowledge accumulation; see also Research and development model and allocation of resources, 116–123, 132–133 and basic scientific research, 118 and capital accumulation, 101, 121–122 and central questions of growth theory, 143–145 and cross-country income differences, 32, 143–145, 149 dynamics of, 104–109 endogenous, 103–104, 111, 138–143 and ever-increasing growth, 108–109 and learning-by-doing, 121–123, 136–137, 146–147 over human history, 138–143 private incentives for, 118–120 in Romer model, 123n and talented individuals, 120–121 and worldwide economic growth, 145 Kremer model, 138–143 L Labor-augmenting technological progress, 10, 13n Labor demand and employment movements, 456–457, 461–463, 482, 484–486, 499–501 with flexible wages and competitive labor, 247–248 in real-business-cycle models, 194 705 in search and matching models, 494–496 in Shapiro-Stiglitz model, 472–476 Labor-force attachment, 485–486 Labor market; see also Contracting models; Contracts; Efficiency wages; Unemployment; Wages competitive, 246–249 cyclical behavior of, 253–255, 456–457 dual, 477 economy-wide, 293 heterogeneity of, 486, 492–493 imperfections in, 249–250, 284–286 in insider-outsider model, 482–484 real rigidity in, 283–286 in search and matching models, 488–489 short-side rule, 307 turnover in, 474, 475, 477, 493–494 and wage rigidities, 251–253, 456–457, 480–481, 496 Labor mobility, 283–284 Labor supply in dynamic new Keynesian models, 316 elasticity of, 300, 456, 482 and hours of work, 530 and hysteresis, 485 in imperfect competition model, 271 inelastic, 213–214, 277–278 intertemporal substitution in, 197–199, 204, 214–215 in Ramsey-Cass-Koopmans model, 50 raw labor vs human capital, 152 in real-business-cycle models, 194, 197–199, 201–204, 209 in research and development model, 103, 106–107 in Romer model, 126 in Shapiro-Stiglitz model, 473–474 in Solow model, 13–14 tradeoff with consumption, 201 Lag operators, 205n, 323, 326–328 Land, 38–43, 139, 141 Law of iterated projections, 265, 328n, 428 Layoffs, 477, 504–506 Leaders death of, and policy changes, 170–171, 223 differences in beliefs, 172 Learning-by-doing, 121–123, 136–137, 146–147 706 Subject Index Lehman Brothers, 645 Level effects, on balanced growth path, 20–21 Life-cycle saving, 395n, 398 Limited liability, in debt markets, 301 Linear growth models, 109, 133 Liquidity, concept of, 648 Liquidity constraints, 378–379, 393–397, 597, 630 Liquidity effect, 518 Liquidity trap, 308, 553; see also Zero nominal interest rate LM curve, 242, 262 Log-linear approximation, 196n, 207–211, 236–237 Loglinearization, 207 Logarithmic utility in Diamond model, 80, 82–84, 97 in Ramsey-Cass-Koopmans model, 51, 94 in real-business-cycle models, 196–197, 202 in Romer model, 126 in Tabellini-Alesina model, 615–617 Lognormal distribution, 210n Long-term interest rates, 422, 518–523 Lucas asset-pricing model, 401 Lucas critique, 298–299 Lucas imperfect-information model, 292–301, 303–304, 306 Lucas supply curve, 295–296, 331, 340–341, 528, 555 M Macroeconomic crisis of 2008–; see Economic crisis of 2008– Malthusian determination of population, 139 Mankiw-Reis model, 314, 347–352, 363–364 Marginal disutility of work, 480–481, 482, 499 Marginal product of capital in Diamond model, 78, 88, 91 in learning-by-doing model, 147 private, 147 in q theory model, 411, 416, 419 in Ramsey-Cass-Koopmans model, 51 in simple investment model, 407–408 in Solow model, 12, 21, 24–25, 28, 29n Marginal q, 414–415, 426 Marginal revenue-marginal cost diagram, 275–276, 281–283 Market beta, 387n Markup countercyclical, 248–249, 282–283, 286 in imperfect competition model, 272 by intermediaries, 359 procyclical, 249n and real rigidity, 282–283 with wage rigidity, flexible prices, and imperfect goods, 251 Markup function, 251 Martingale, 373n Matching function, 487, 488–489, 512 Maturity transformation, 646 Measurement error classical, 166 and convergence, 35, 48 and cross-country income differences, 166, 167, 186–187 and interest-rate rules, 545–546 and q theory tests, 426, 427 Median-voter theorem, 610–612 Medical costs, 584, 590–592 Menu costs; see also Price adjustment and average inflation, 304–306 defined, 267 and efficiency wages, 466n empirical evidence on, 339–340 with imperfect competition, 276–278, 283, 284–286 with multiple equilibria, 308–309 and persistence of output movements, 306 and profit function insensitivity, 280 and real rigidity, 278–284, 292 Method of undetermined coefficients, 208–211, 235n, 323–325, 355–356 Minimum wage, 457n Models, purpose of, 3–4, 14–15 Modified golden-rule capital stock, 65 Modigliani-Miller theorem, 455 Monetary conditions index, 546 Monetary disturbances; see also Aggregate demand shocks in canonical new Keynesian model, 354–356 in Caplin-Spulber model, 337 in Danziger-Golosov-Lucas model, 335–337 with exogenous price rigidity, 242–243 and incentives for price adjustment, 276–278, 284–286 and inflation shocks, 354, 356 long-lasting effects of, 325–326 in Lucas model, 292, 295 and natural experiments, 222–224 Subject Index and predetermined prices, 322, 348 with price rigidity, 242–243 in real-business-cycle models, 195, 220–226 and St Louis equation, 221–222 in Taylor model, 325–326 and vector autoregressions, 225–226 Monetary policy, 513–583; see also Dynamic inconsistency; Interest-rate rules; Policymakers; Stabilization policy backward-looking model, 531–536 in canonical new Keynesian model, 352–354, 356, 364 and central bank independence, 562–564 control of interest rates, 307–308 and delegation, 560–563, 581 and economic crisis of 2008–, 645 and exchange rates, 546, 552 and financial-market imperfections, 449 forecasts in, 546n forward-looking model, 537–542 and the Great Inflation, 564–567 inflation bias in, 513–514 inflation targeting, 223n, 535 k-percent rule, 543 and Lucas critique, 299 and money growth effects, 515–518, 576–577, 579 and natural experiments, 223–224 and natural-rate hypothesis, 257 in new Keynesian models, 319, 359–360 overview of, 513–514 and political business cycles, 582 and regime changes, 577–579 and reputation, 580–581 and rules, 543–544, 558–559 and St Louis equation, 222 and seignorage, 513–514, 567–576, 582–583 and social welfare, 527–531 super-inertial, 547 and term structure of interest rates, 518–523, 577, 578–579 and uncertainty, 545, 579–580 and vector autoregressions, 225–226 and zero lower bound, 308, 526–527, 539n, 550–554, 580, 647–648 Money in baseline price rigidity model, 239–240 707 high-powered, 302n, 523, 524, 550, 568 in Samuelson overlapping-generations model, 98–100 as source of utility, 239–240 Money demand in baseline price rigidity model, 241–242 and future inflation, 572n, 576n gradual adjustment of, 572–574 and inflation, 514–515 and St Louis equation, 222 and seignorage, 568–570 and vector autoregressions, 225 Money growth and hyperinflation, 567–568, 572–576 inflation from, 514–518 and interest rates, 515–518 and real money balances, 516–518, 568–576, 576–577 and seignorage, 568–576, 582–583 Money-in-the-utility-function, 240n, 269 Money market, 262 Money-output regressions, 225–226 Money-stock rules, 543–544 Monopoly power, 123, 125, 127, 147, 163n Moral hazard, 301, 444 Mortensen-Pissarides model, 486, 511–512; see also Search and matching models MP curve, 262–264, 308 Multiple equilibria in coordination-failure models, 286–290 defined, 266–267 in Diamond model, 86–87 and economic crisis of 2008–, 646 with menu costs, 308–309 in model of debt crises, 635–636, 638 punishment, 559n, 581–582 real non-Walrasian theories, 290–292 Multiplier-accelerator, 306–307 Multisector models, 230 N Nash bargaining, 488, 490 Nash equilibrium, 277, 289, 643 National Bureau of Economic Research, 189n Natural experiments, 168–169, 222–224 Natural-rate hypothesis, 257–258, 566, 644 708 Subject Index Natural rate of interest, 535–536, 538–539, 545 Natural rate of output, 259, 545–546, 566 Natural rate of unemployment, 257, 307, 485, 498 Natural resources, 11, 37–43 New growth theory; see Human capital; Income differences, cross-country; Knowledge accumulation; Research and development model New Keynesian IS curve, 241, 261–262, 264, 316, 352–353, 356–358, 537, 539 New Keynesian models; see Dynamic new Keynesian models New Keynesian Phillips curve in canonical new Keynesian model, 352–353, 356 derivation of, 329–331 in forward-looking monetary policy model, 537–539, 541 with indexation, 344–347, 357, 363 and inflation inertia, 340–344, 357 and long-run output-inflation tradeoff, 554n in new Keynesian models, 357 with partial indexation, 363 with wage inflation, 357 New political economy, 605–607 Newly industrializing countries, 7, 31 No-bubbles condition, 400 No-Ponzi-game condition, 53, 55 No-shirking condition, 471–474 Nominal adjustment, incomplete, 267–306; see also Dynamic stochastic general-equilibrium models; Lucas imperfectinformation model; Price adjustment baseline imperfect competition model, 268–274 coordination-failure models, 286–290, 310 in debt markets, 301–302 incentives for, 275–278, 284–286 liquidity effect, 518 Nominal rigidity; see also Price rigidity in DSGE models, 314 exogenous, 239–267 overview of, 238–239 in real-business-cycle models, 195, 229, 231–233 and small barriers to price adjustment, 275–278, 280, 282, 284–286 Non-lump-sum taxation, 639–640 Nonexpected utility, 390n Nonrivalry of knowledge, 117, 144 Nonstationarity vs stationarity, 134–136 Nontradable consumption goods, 160, 161 O Observational equivalence, 311 Oil prices, 38, 258, 624 Okun’s law, 193 Olivera-Tanzi effect, 571n Omitted-variable bias, 165, 166, 626 Open-market operations, 550–553 Option value to waiting, 432 Output-inflation tradeoff accelerationist Phillips curve, 260–262, 331, 340–342, 528, 532 and average inflation rate, 304–306 and backward-looking monetary policy model, 533–536 expectations-augmented Phillips curve, 259–261, 296 failure of Phillips curve, 257–258 and forward-looking monetary policy model, 541–542 and the Great Inflation, 565–566 hybrid Phillips curve, 261, 341–343 and hyperinflation, 567 and inflation bias, 513, 554 international evidence on, 302–306 in Lucas model, 298, 303–304 and natural-rate hypothesis, 257–258 and new Keynesian Phillips curve, 554n Phillips curve, 256 Output taxation, 230 Overidentifying restrictions, 377n Overlapping-generations models, 9, 77n, 98–100; see also Diamond model P Panel Study of Income Dynamics (PSID), 253–254, 378 Pareto efficiency and budget deficits, 630 in specific models, 63, 88–90, 119n, 202, 204, 232, 288–290 Partial-equilibrium search, 511 Partial vs general equilibrium models, 232 Patent laws, 117 Pay-as-you-go social security, 97–98 Subject Index Pecuniary externalities, 64n, 119n Penn World Tables, 7n, 158 Perfect competition; see Competition, perfect Permanent income, 367, 370–371 Permanent-income hypothesis derivation of, 365–367 and excess smoothness of consumption, 375n failures of, 389–390 implications of, 367–371, 379 and random-walk hypothesis, 373 and Ricardian equivalence, 596–598 Persson-Svensson model, 608, 641 Phase diagrams with kinked adjustment costs, 433–434 in q theory model, 417–418, 420–421, 423–425 in Ramsey-Cass-Koopmans model, 59–60, 65, 69, 96 in research and development model, 105–108, 112–115 in Solow model, 17 sustainable vs unsustainable seignorage, 574–575 with uncertainty, 429–431 Phillips curve; see also New Keynesian Phillips curve; Output-inflation tradeoff accelerationist, 260–262, 331, 340–342, 528, 532 expectations-augmented, 259–261, 296 failure of, 257–258 history of, 256 hybrid, 261, 341–343 and Lucas critique, 298–299 and natural-rate hypothesis, 257–258 and productivity growth, 307 Poisson processes, 329–330, 344, 348, 468–469 Policies vs institutions, 170–171 Policy rules, 544–546, 566, 577–579; see also Interest-rate rules Policymakers; see also Fiscal policy; Monetary policy; Stabilization policy commitment by, 554–558, 614 delegation to, 560–563 disagreements among, 613–615 discretion of, 555–558 and economic crisis of 2008–, 648 and the Great Inflation, 565–567 incentive contracts for, 559n incomplete knowledge of, 605–606 709 independence of, 562–564 inflation choices of, 541–542, 554–558, 560–562 inflation targeting, 535 known inefficient outcomes, 606–607 liberal vs conservative, 608, 641 and maximization of social welfare, 360 and preferences, 610–612, 615 reasons for accumulating debt, 607–608 and reputation, 559–560, 580–581 rules vs discretion, 558–559 and statistical relationships, 299 and status-quo bias, 642 Political business cycles, 582 Political-economy theories of budget deficits, 604–607, 624, 648 Political participation, 614–615 Political power, 171, 624–627 Political Risk Services, 167 Pollution, 43–45 Ponzi games, 53, 588–590 Population exogenous growth of, 13–14, 50, 78, 104, 196 and long-run economic growth, 106, 108, 110–111, 114, 122, 131, 137–143 Malthusian determination of, 139, 142 over very long run, 138–143 in specific regions, 141 turnover in, 77, 595 Potential output, 259, 262 Precautionary saving, 390–393, 395, 403, 597–598, 639–640 Predetermined prices, 314; see also Fischer model; Mankiw-Reis model Present-value Hamiltonian, 413n Presidential political systems, 626 Price adjustment; see also Inflation; Menu costs; State-dependent price adjustment; Time-dependent price adjustment of assets, 401, 547–548, 646–647 barriers to, 275–276 in Calvo model, 329–331 in canonical new Keynesian model, 352, 353 in Caplin-Spulber model, 332–333 in Christiano-Eichenbaum-Evans model, 344–347 in coordination-failure models, 286–290 710 Subject Index Price adjustment (continued) costs of, 339–340 and costs of inflation, 524–525 in Danziger-Golosov-Lucas model, 333–337 in dynamic new Keynesian models, 317–319 in Fischer model, 319–322, 361 and fixed prices, 322–328 frequency of, 337–339, 352 of housing, 644–645, 646 imperfect competition model, 268–274 and imperfect information, 292–293 incentives for in contracting models, 482 and efficiency wages, 461, 465, 466n, 467 and real rigidity, 278–286 and small frictions, 275–278 incomplete, 321, 326 and inflation inertia, 340–344 in Mankiw-Reis model, 347–352 microeconomic evidence on, 337–340 and monetary policy, 224 real non-Walrasian theories, 290–292 and real rigidity, 278–286 and sales, 338–339 synchronized, 362 and taxes, 427 in Taylor model, 322–328 Price indexes in imperfect competition model, 271 limitations of, 6n in Lucas model, 294 Price-level inertia, 325 Price-level paths, 551 Price-price Phillips curve, 307 Price rigidity; see Nominal rigidity; Price adjustment Price-setters in Calvo model, 329–331 in Caplin-Spulber model, 332–333 in Danziger-Golosov-Lucas model, 333–337 in Fischer model, 319–322 in imperfect competition model, 268–274 incentive to obtain information, 300–301 in Mankiw-Reis model, 347–352 and small barriers to adjustment, 275–278 and sticky information, 348 in Taylor model, 322–328 Pricing kernel, 386 Primary deficit, 587 Primary jobs, 477 Private incentives for innovation, 118–120 Private vs social returns; see Social infrastructure Production functions; see also Cobb-Douglas production function aggregation over firms, 93 in baseline real-business-cycle model, 195 in Diamond model, 78 in dynamic new Keynesian models, 316 Ethier, 124–125 for human capital, 152 Inada conditions, 12, 16–17 intensive form of, 11–12, 13 for knowledge, 102–104, 112 and learning-by-doing, 121–123 in Ramsey-Cass-Koopmans model, 49 in real-business-cycle models, 195, 202, 205 in research and development model, 102–104, 112 in Romer model, 124–126 in Samuelson model, 98 in Solow model, 10–13, 29n, 151–152 Productivity growth impact on Phillips curve, 307 rebound in, 6, 32 in research and development, 131 slowdown in, 6, 31–32, 94, 193 Profit functions in contracting models, 479 insensitivity of, 280–281 in Romer model, 129–130 in search and matching models, 496 Property rights, 38, 117, 121, 127, 144 Proportional output taxation, 230 Proportional representation, 626 PSID (Panel Study of Income Dynamics), 253–254, 378 Punishment equilibria, 559n, 581–582 Q q theory model of investment, 408–436 with constant returns in adjustment, 415n, 454 with kinked and fixed adjustment costs, 432–436, 454 and money demand, 572n and taxes, 423–425, 453 and uncertainty, 428–432, 454 Subject Index q (value of capital), 410, 411, 414–415, 425–428 Quadratic adjustment costs, 425 Quadratic utility, 372, 374–375, 385, 390–391, 394–395 Quality-ladder models, 133–134 Quantitative easing, 550–551, 553 R Ramsey-Cass-Koopmans model, 49–77 vs baseline real-business-cycle model, 194–195, 199–200 capital taxation in, 95–96 closed-form solution for, 95 vs Diamond model, 49, 77, 79, 83, 87–88 government purchases in, 71–77, 96–97 vs research and development model, 106 and Ricardian equivalence result, 592–594 social planner’s problem, 63–64, 452 vs Solow model, 49, 64–65, 66, 71 Random walk, 298, 322, 328, 601, 640 Random walk with drift, 298 Random-walk hypothesis, 373, 375–380 Rational expectations, 261, 294, 295, 577–579 Rational political business cycles, 582 Raw labor vs human capital, 152 Reaction function, 286–288, 290–292 Real-business-cycle theory, 189–237 with additive technology shocks, 234–235 evaluation of models, 220, 226–229 monetary disturbances in, 220–226 overview of, 193–195, 231–233 with taste shocks, 235, 297 Real non-Walrasian theories, 290–292 Real rigidity in Calvo model, 329 in Fischer model, 322 in Mankiw-Reis model, 348, 350 and multiple equilibria, 286, 289 overview of, 278–280 and real non-Walrasian theories, 290–292 and small barriers to price adjustment, 284–286 sources of, 281–284 in Taylor model, 326 711 Real-wage function, 249, 250, 284 Recessions; see also Economic crisis of 2008–; Great Depression and consumption variability, 529 and socially optimal output, 273–274 and tax-smoothing, 602 in United States, 189–193 wage rigidity during, 504, 506 welfare effects of, 273–274, 527–531 Regime changes, 577–579 Renegotiation-proof contracts, 440n Rent-seeking, 120, 162–163 Reputation, and dynamic inconsistency, 559–560, 580–581 Research and development; see also Knowledge determinants of, 116–123 externalities from, 119–120, 127, 132 free-entry condition in, 127 production function for, 102–104 and returns to scale, 103, 109–110, 112 Research and development effect, 119, 127, 132 Research and development model, 102–116, 137, 143–145, 149 Returns to scale constant in adjustment costs, 434–435, 454 in q theory model, 414–415, 425 in research and development model, 103, 109–110, 112 in Romer model, 123n in search and matching models, 488–489 in simple investment model, 409 in Solow model, 10–11 diminishing and entrepreneurial activity, 120–121 and lack of growth, 137–138 in q theory model, 414 in research and development model, 103, 109–110, 112 and entrepreneurial activity, 120–121 increasing and human capital, 186 in research and development model, 103, 109–110, 112 in Romer model, 123n in knowledge production, 103, 109–110, 112 to produced factors, 109–110, 112, 115–116 712 Subject Index Ricardian equivalence, 592–598 and precautionary saving, 597–598, 639–640 in Tabellini-Alesina model, 608–609 and tax cuts, 603–604 and welfare costs of deficits, 629–630 Rigidity; see Nominal rigidity; Price rigidity; Real rigidity Risk aversion in contracting models, 480 in debt markets, 301 and equity-premium puzzle, 388–389 and precautionary saving, 391–392 and stabilization policy, 529–531 Risky assets, and consumption, 384–389 Risky projects, and investment, 432 Rival goods, 117 Romer model, 103, 118, 123–134, 147 Rule-of-thumb consumption behavior, 397, 630 Runs, and economic crisis of 2008–, 645–646 S Saddle paths, 62–63, 67–70, 72–73, 418–421, 423–425, 429–431, 433–434 St Louis equation, 221–222 Sale prices, 338–339 Sample-selection bias, 34–35 Samuelson overlapping-generations model, 98–100 Saving; see also Consumption buffer-stock, 389–390, 395n, 597 in Diamond model, 78, 85–88, 92–93 and discount rate, 393, 395 as future consumption, 367–368 and interest rates, 380–384 life-cycle, 395n, 398 and liquidity constraints, 393–397 over long horizons, 383–384 precautionary, 390–393, 395, 403, 597–598, 639–640 and productivity slowdown, 94 in Ramsey-Cass-Koopmans model, 64–65 and relative consumption, 368 Saving rate and capital-output ratio, 160–161 in Diamond model, 49, 80, 82, 85–86 endogenous, 9, 49 and externalities from capital, 174 and investment rate, 18–19, 36–37 and learning-by-doing, 122 and long-run growth, 115, 122, 138 in Ramsey-Cass-Koopmans model, 49, 64 in real-business-cycle models, 202–203, 206 in research and development model, 104 in Solow model, 9, 18–25, 65, 153, 154 Scale effects, 109–110, 115–116 Scientific research, 118 Search and matching frictions, 283, 487 Search and matching models, 486–498 competitive, 493 defined, 458 partial-equilibrium, 511 Seasonal fluctuations, 191n Secondary jobs, 477 Sector-specific shocks, 230–231, 631 Seignorage, 513–514, 567–576, 582–583 Selection effect, 332, 333–337 Self-fulfilling prophecies, 87, 266–267, 288, 539–540, 637; see also Multiple equilibria Semi-endogenous growth models, 114, 133, 137 Settler colonies vs extractive states, 176–177 Severe punishment, 582 Shapiro-Stiglitz model, 467–478, 487, 489, 505, 507–508 Shoe-leather costs, 524 Short-side rule, 307 Short-term interest rates, 422, 518–523 Signal extraction, 296 Signal-to-noise ratio, 296 Single-peaked preferences, 610–611 Slavery and colonialism, 176 Smets-Wouters model, 312, 357 Social infrastructure, 162–177, 183, 186–187 Social security, 97–98, 584, 591 Social welfare; see Welfare (social) Solow model, 6–48 vs Diamond model, 49, 83, 85, 87–88 discrete-time version of, 97 with human capital, 151–156, 185 microeconomic foundations for, 97 vs Ramsey-Cass-Koopmans model, 49, 64–66, 71 vs research and development model, 106 speed of convergence in, 25–27, 71 Solow residual, 30–31, 218, 227 Subject Index Spending bias, 627 Ss policy, 332, 334, 337 Stabilization policy; see also Fiscal policy; Monetary policy; Policymakers in backward-looking monetary policy model, 533–534 case for, 528–531 delayed, 617–623, 642 and imperfect information, 299–300 and inflation, 523–527 and output, 527–528 overview of, 513 Staggered price adjustment; see also Caplin-Spulber model; Fischer model; Mankiw-Reis model; Taylor model Calvo model, 331 Christiano-Eichenbaum-Evans model, 314, 344–347, 351–352 instability of, 361–362 Mankiw-Reis model, 314, 347–352, 363–364 Staggered wage adjustment, 319n State-dependent price adjustment Caplin-Spulber model, 314, 332–333, 337, 362–363 Danziger-Golosov-Lucas model, 314, 333–337 defined, 313 with positive and negative inflation, 362–363 shortcomings of, 339 State variable, 413 Stationarity vs nonstationarity, 134–136 Status-quo bias, 642 Stein’s law, 630 Sticky information; see Mankiw-Reis model Stochastic discount factor, 386 Stock-price movements, 388–389 Straight-line depreciation, 452 Strategic debt accumulation, 607–617, 628, 640–641 Substitution effect in consumption under certainty, 381, 383 in Diamond model, 80 in real-business-cycle models, 198, 203 Sunspot equilibria, 87, 266–267, 288, 539–540; see also Multiple equilibria Super-inertial monetary policy, 547 Supply shocks; see Aggregate supply shocks 713 Symmetric adjustment costs, 429–430 Symmetric equilibrium, 272 Symmetric information, 438 Synchronized price-setting, 362 T Tabellini-Alesina model, 608–617, 628, 640–641 Talented individuals, 120–121 Tanzi effect, 571n Taste shocks, 235, 297 Tax cuts of 2001 and 2003, 591 of 2008 and 2009, 594 expectations of, 603–604 and zero lower bound, 552n Tax-smoothing departures from, 624, 629, 630 model of, 584–585, 598–604, 640 Tax vs debt financing, 71, 196n, 592–594 Taxes in baseline real-business-cycle model, 196 vs budget deficits, 592–598 and capital, 95–96, 407, 602–603 and consumption, 379, 383 and costs of inflation, 524 distortionary, 230, 598–604, 608–609, 629, 640 expected vs unexpected changes in, 96 and inflation, 569 and investment, 95–96, 426–432, 445, 453 non-lump-sum, 639–640 on pollution, 43–44 in Ramsey-Cass-Koopmans model, 71–72 and social infrastructure, 163 Taylor model, 322–328 continuous-time version of, 363 vs other models, 314, 329, 333 overview of, 313–314 synchronized price-setting in, 362 Taylor rules, 544–546, 566; see also Interest-rate rules Taylor-series approximations, 25, 27n, 67, 207–211, 388 Technological change; see also Knowledge accumulation capital-augmenting, 10n, 13n embodied, 47–48 endogenous, 9, 106, 138–139 Harrod-neutral, 10 Hicks-neutral, 10n, 13n 714 Subject Index Technological change (continued) labor-augmenting, 10, 13n and learning-by-doing, 121–123 in medicine, 591 vs natural resource limitations, 40–43 and population growth, 138–143 in research and development model, 102 in Romer model, 133 as worldwide phenomenon, 140–141 Technology; see Knowledge; Knowledge accumulation; Research and development Technology shocks additive, 234–235 in real-business-cycle models, 194, 197, 206, 209, 211–215, 227–228, 234–235 Term premium, 519, 523n Term structure of interest rates, 518–523, 578–579 Thick-market effects, 282, 310, 488 Time-averaging problem, 399 Time-dependent price adjustment Calvo model, 313–314, 329–331, 333, 344–345, 362 Christiano-Eichenbaum-Evans model, 312, 314, 344–347, 351–352, 357 defined, 313 Fischer model, 313–314, 319–322, 333, 348, 361–362 fixed vs predetermined prices, 314 Mankiw-Reis model, 314, 347–352, 363–364 shortcomings of, 339, 351–352 Taylor model, 313–314, 322–328, 333, 363 Time-inconsistent preferences, 397–398, 403–404 Time-to-build, 231n Tobin’s q, 414–415, 425–428 Tradable consumption goods, 161 Trade balances, and debt crises, 631 Transactions demand for money, 240n Transfer payments, 599n, 602n Transition dynamics, 123, 124, 133 Transitory income, 367, 370–371 Transparent institutions, 627–628 Transversality condition, 412, 413, 418 Trend stationarity, 134–136 Tropical countries, poverty in, 174–178 Two-stage least squares, 165; see also Instrumental variables U Unbalanced price-setting, 361 Uncertainty consumption under, 372–375, 390–393 and dynamic efficiency, 91, 590n and fiscal policy, 592 and household optimization, 199–200 investment under, 428–432, 436, 455 and monetary policy, 579–580 and price-setting, 318 tax-smoothing under, 601 Underemployment equilibria, 288 Underlying (core) inflation, 259–261 Undetermined coefficients, method of; see Method of undetermined coefficients Unemployment, 456–512; see also Labor market basic macro issues, 456–458 contracting models, 457, 478–486, 498–501, 509–510 and cyclical real wage, 253–255 determinants of, 456 and economic crisis of 2008–, 645 and efficiency wages, 458–467, 506–507 equilibrium level of, 465, 473–474 in Europe, 485–486 and fair-wage effort hypothesis, 508–509 frictional, 493 Harris-Todaro model, 510–511 insider-outsider models, 482–486, 510 and interindustry wage differences, 501–504 long-term, 494 natural rate of, 257, 307, 485, 498 and Okun’s law, 193 during recessions, 192–193 search and matching models, 486–498 from sector-specific shocks, 230–231 Shapiro-Stiglitz model, 467–478, 487, 489, 505, 507–508 and wage rigidities, 504–506 Unemployment benefits, 485 Unemployment-inflation tradeoff; see Output-inflation tradeoff Unfunded liabilities, 588, 590 Union contracts, 378–379, 499–501 Union wage premium, 506–507 Unit circle, 540 United Kingdom Great Inflation in, 564, 565 inflation-indexed bonds in, 523n Subject Index tax financing in, 629 wartime interest rates in, 75–77 United States budget deficits in, 584, 590–592, 594, 604 data for calibration of model, 218–219 dynamic efficiency in, 90–92 fiscal policy in, 584, 590–592, 618, 623n, 629 future government spending in, 607 Great Inflation in, 564, 565 historical movement of money, 222–223 income stationarity in, 135 inflation-indexed bonds, 523n recessions in, 189–193 tax cuts, 591, 594 User cost of capital, 406–407 Utility functions; see also Instantaneous utility functions constant-absolute-risk-aversion, 403 constant-relative-risk-aversion, 50–51, 78, 94, 239, 380, 387 logarithmic, 51, 80, 82–84, 94, 97, 126, 196–197, 202, 615–617 money in, 240n, 269 quadratic, 372, 374–375, 385, 390–391, 394, 395 Utility, nonexpected, 390n V Vacancy-filling rate, 489– 491 Value function, 235, 469–470, 489–490 Vector autoregressions (VARs), 225–226 Verification costs, in asymmetric information model, 438–444 Volcker disinflation, 644 Voters and Concordet paradox, 640 puzzle of participation, 614–615 and status-quo bias, 642 in Tabellini-Alesina model, 610–612, 614–615, 640–641 W Wage contracts, 480–481 Wage inflation, 259n, 357 Wage-price Phillips curve, 307 Wage rigidity in Fischer and Taylor models, 319n with flexible prices and competitive goods, 245–246 715 with flexible prices and imperfect goods, 250–253 and inflation, 526 and labor market shifts, 456–457 in search and matching models, 496 and small barriers to wage adjustment, 284n survey evidence on, 504–506 and wage contracts, 480–481, 498–501 Wage-wage Phillips curve, 307 Wages; see also Efficiency wages; Price adjustment; Unemployment and aggregate demand, 457 and consumption predictability, 378–379 cuts in, 457–458, 465–467, 477, 505–506 cyclical behavior of, 193, 246, 248, 251, 253–255, 456–457 and education, 153 and fairness, 505–506 and government purchases, 216–217 and human capital, 159–160 and incentives for price adjustment, 278, 283–286, 457, 461, 465, 466n, 467, 482 and inflation, 256–258, 526 in insider-outsider model, 482–486, 510 interindustry differences in, 501–504 and labor supply, 456 posted, 493 in Ramsey-Cass-Koopmans model, 51–52, 64n in real-business-cycle models, 196, 198–199, 206, 209 during recessions, 193 reservation, 466n in Romer model, 129 in search and matching models, 487–488, 490–491, 493, 496 setting, 484–486, 504–506 and signing of new contracts, 498–501 staggered adjustment of, 319n subsidies, 476 and technology shocks, 209, 213 and unions, 506–507 Waiting, option value to, 432 War of attrition, 618 Wartime government purchases, 75–77, 602 Weak governments, and budget deficits, 624–627 716 Subject Index Wealth redistribution, 301–302, 630, 632 Welfare (social) and booms and recessions, 273–274, 527–531 and budget deficits, 629–632, 642 and consumption variability, 529–531 in Diamond model, 88–90 and inflation, 523–527 and long-run growth, 6, 7–8 and pollution, 44–45 in Ramsey-Cass-Koopmans model, 63–64 and stabilization policy, 527–531 and unemployment, 497–498 and variability in hours of work, 530 White-noise disturbances, 134, 197, 205, 298, 322, 353–355, 533, 537, 542 Whites vs blacks, consumption of, 369–370, 371 Work-sharing vs layoffs, 477 Workers; see also Labor market; Unemployment abilities of, 159–160, 458, 485, 502–503 in Alesina-Drazen model, 619–623 heterogeneity of, 457–458, 486, 492–493 insiders and outsiders, 483 long-term relationships with employers, 478–479 migration of, 159 monitoring of, 458 perceptions of fairness, 505–506 and students, 154–156 wealth redistribution from, 630 World War II and cross-country income differences, 180, 182 magnitude of fluctuations before and after, 192 UK tax financing during, 629 Y Y = AK models, 109 Z Zero-coupon bonds, 519 Zero nominal interest rate and economic crisis of 2008–, 647–648 in forward-looking monetary policy model, 539n importance of, 550–554, 580 and inflation, 526–527 and liquidity trap, 308, 553 ... Fourteenth Edition ADVANCED MACROECONOMICS Fourth Edition David Romer University of California, Berkeley iii Romer-1820130 rom11374˙fm˙i-xx February 17, 2011 8:12 iv ADVANCED MACROECONOMICS, FOURTH... Library of Congress Cataloging-in-Publication Data Romer, David Advanced macroeconomics / David Romer — 4th ed p cm ISBN 978-0-07-351137-5 Macroeconomics I Title HB172.5.R66 2012 339—dc22 2010040893... Edition Dornbusch, Fischer, and Startz Macroeconomics Eleventh Edition Frank Microeconomics and Behavior Eighth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Fourth Edition ii McConnell,