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(BQ) Part 2 book Macroeconomics - Policy and practice has contents: Aggregate supply and the phillips curve, the aggregate demand and supply model, macroeconomic policy and aggregate demand and supply analysis, the financial system and economic growth, the financial system and economic growth, fiscal policy and the government budget,...and other contents.
www.downloadslide.com Aggregate Supply and the Phillips Curve 11 Preview In the 1960s, the Kennedy and Johnson administrations followed the advice of Nobel Prize winners Paul Samuelson and Robert Solow and pursued expansionary macroeconomic policies to raise inflation a little bit, with the expectation that unemployment would be permanently lower They were disappointed when, in the late 1960s and the 1970s, inflation accelerated and yet the unemployment rate stayed uncomfortably high To understand why they were wrong, we turn to a concept called the Phillips curve, which describes the relationship between unemployment and inflation In the preceding chapter, we derived the aggregate demand curve, which shows the relationship between the inflation rate and the level of aggregate output when the goods market is in equilibrium But how we determine aggregate output and inflation? The aggregate demand curve provides half of the story; we also need to factor in the relationship between these two variables that is provided by the aggregate supply curve, which we develop in this chapter The Phillips curve provides the intuition for the aggregate supply curve First, we will see how the economic profession’s views on the Phillips curve have evolved over time and how this evolution has affected thinking about macroeconomic policy Then we can use the Phillips curve to derive the aggregate supply curve, which will allow us to complete our basic aggregate demand-aggregate supply framework for analyzing short-run economic fluctuations in the next chapter The Phillips Curve In 1958, New Zealand economist A.W Phillips published a famous empirical paper that examined the relationship between unemployment and wage growth in the United Kingdom.1 For the years 1861 to 1957, he found that periods of low unemployment were associated with rapid rises in wages, while periods of high unemployment were characterized by low growth in wages Other economists soon extended his work to many other countries Because inflation is more central to macroeconomic issues than wage growth, they estimated the relationship between unemployment and inflation The negative relationship between unemployment and inflation that they found in many countries became known, naturally enough, as the Phillips curve 1A.W Phillips, “The Relationship Between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861–1957,” Economica 25 (November 1958): 283–299 281 www.downloadslide.com 282 Part four • Business Cycles: The Short Run The idea behind the Phillips curve is quite intuitive When labor markets are tight— that is, the unemployment rate is low—firms may have difficulty hiring qualified workers and may even have a hard time keeping their present employees Because of the shortage of workers in the labor market, firms will raise wages to attract needed workers and raise their prices at a more rapid rate Phillips Curve Analysis in the 1960s Because wage inflation feeds directly into overall inflation, in the 1960s, the Phillips curve became extremely popular as an explanation for inflation fluctuations because it seemed to fit the data so well As shown in panel (a) of Figure 11.1’s plot of the U.S inflation rate against the unemployment rate from 1950 to 1969, there is a very clear negative relationship between unemployment and inflation The Phillips curve for that period seemed to imply that there is a long-run trade-off between unemployment and inflation—that is, policy makers can choose policies that lead to a higher rate of inflation Figure 11.1 16% 14% 12% 10% 8% 6% 4% 2% 0% 0% 4% 6% 8% 10% 12% 10% 12% (b) Inflation and Unemployment, 1970–2013 16% 14% 1980 12% 1974 10% 1979 8% 1973 6% 4% 2% 0% 0% Source: Economic Report of the President www gpoaccess.gov/eop/ 2% Unemployment Rate (percent) Inflation Rate (percent) The plot of inflation against unemployment over the 1950–1969 period in panel (a) shows that a higher inflation rate was generally associated with a lower rate of unemployment Panel (b) shows that after 1970, the negative relationship between inflation and unemployment disappeared (a) Inflation and Unemployment, 1950–1969 Inflation Rate (percent) Inflation and Unemployment in the United States, 1950–1969 and 1970–2013 2% 4% 6% 8% Unemployment Rate (percent) www.downloadslide.com Chapter 11 • Aggregate Supply and the Phillips Curve 283 Policy and Practice The Phillips Curve Tradeoff and Macroeconomic Policy in the 1960s In 1960, Paul Samuelson and Robert Solow published a paper outlining how policy makers could exploit the Phillips curve trade-off The policy maker could choose between two competing goals—inflation and unemployment—and decide how high an inflation rate he or she would be willing to accept to attain a lower unemployment rate.2 Indeed, Samuelson and Solow even said that policy makers could achieve a “nonperfectionist” goal of a 3% unemployment rate at what they considered to be a tolerable inflation rate of 4–5% per year This thinking was influential during the Kennedy and then Johnson administrations, and contributed to the adoption of policies in the mid-1960s to stimulate the economy and bring the unemployment rate down to low levels At first these policies seemed to be successful because the subsequent higher inflation rates were accompanied by a fall in the unemployment rate However, the good times were not to last: from the late 1960s through the 1970s, inflation accelerated, yet the unemployment rate remained stubbornly high and end up with a lower unemployment rate on a sustained basis This apparent tradeoff was very influential in policy circles in the 1960s, as we can see in the Policy and Practice case The Friedman-Phelps Phillips Curve Analysis In 1967 and 1968, Milton Friedman and Edmund Phelps pointed out a severe theoretical flaw in the Phillips curve analysis:3 it was inconsistent with the view that workers and firms care about real wages, the amount of real goods and services that wages can purchase, and not nominal wages Thus when workers and firms expect the price level to rise, they will adjust nominal wages upward so that the real wage rate does not decrease In other words, wages and overall inflation will rise one-to-one with increases in expected inflation, as well as respond to tightness in the labor market In addition, the Friedman-Phelps analysis suggested that in the long run the economy would reach the level of unemployment that would occur if all wages and prices were flexible, which they called the natural rate of unemployment.4 The natural rate of unemployment is the full-employment level of unemployment, because there will still be some unemployment even when wages and prices are flexible, as we will show in Chapter 20 2Paul A Samuelson and Robert M Solow, “Analytical Aspects of Anti-Inflation Policy,” American Economic Review 50 (May 1960, Papers and Proceedings): 177–194 3Milton Friedman outlined his criticism of the Phillips curve in his 1967 presidential address to the American Economic Association: Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58 (1968): 1–17 Phelps’s reformulation of the Phillips curve analysis is given in Edmund Phelps, “Money-Wage Dynamics and Labor-Market Equilibrium,” Journal of Political Economy 76 (July/August 1968, Part 2): 687–711 4As we will discuss in Chapter 20, there will always be some unemployment that is either frictional unemployment, unemployment that occurs because workers are searching for jobs, or structural unemployment, unemployment that arises from a mismatch of skills with available jobs and is a structural feature of the labor markets Thus even when wages and prices are fully flexible, the natural rate of unemployment is above zero www.downloadslide.com 284 Part four • Business Cycles: The Short Run The Friedman-Phelps reasoning suggested a Phillips curve that we can write as follows: π = πe - ω 1U - Un2 (1) where π represents inflation, πe expected inflation, U the unemployment rate, Un the natural rate of unemployment, and ω the sensitivity of inflation to U - Un The presence of the πe term explains why Equation is also referred to as the expectations-augmented Phillips curve: it indicates that inflation is negatively related to the difference between the unemployment rate and the natural rate of unemployment (U - Un), a measure of tightness in the labor markets called the unemployment gap The expectations-augmented Phillips curve implies that long-run unemployment will be at the natural rate level, as Friedman and Phelps theorized Recognize that in the long run, expected inflation must gravitate to actual inflation, and Equation therefore indicates that U must be equal to Un The Friedman-Phelps expectations-augmented version of the Phillips curve displays no long-run trade-off between unemployment and inflation and is thus consistent with the classical dichotomy that indicates that changes in the price level should not affect the real economy To show this, Figure 11.2 presents the expectations-augmented Phillips curve, marked as PC1, for a given expected inflation rate of 2% and a natural rate of unemployment of 5% (PC1 goes through point because Equation indicates that when π = πe = 2%, U = Un = 5%, and its slope is -ω.) Suppose the economy Mini-lecture Figure 11.2 The Short- and Long-Run Phillips Curves Inflation Rate, p (percent) LRPC Step until the Phillips curve reaches PC3, where unemployment is at the natural rate The expectations10% augmented Phillips curve is downwardPC3 sloping because a lower unemployment rate results in a higher inflation rate for any given level of expected infla3 5% tion If the economy Step Expected inflation rises, moves, due to a decline shifting the PC curve upward… in the unemployment 3.5% rate, from point to point on PC1, the 2% PC2 inflation rate rises If Step A decrease in the unemployment remains PC1 unemployment rate leads at 4%, inflation rises to movement along PC1, U U = 4% = 5% further, shifting the n raising the inflation rate short-run expectationsUnemployment Rate, U augmented Phillips curve upward to PC2 and to point Eventually, when the economy reaches point 4, at which πe = π = 10,, the expectations-augmented Philips curve, PC3, will stop shifting because unemployment is at the natural rate of unemployment The line connecting points and is the long-run Phillips curve, LRPC, and shows that long-run unemployment is at the natural rate of unemployment for any inflation rate www.downloadslide.com Chapter 11 • Aggregate Supply and the Phillips Curve 285 is initially at point 1, where the unemployment rate is at the natural rate level of 5%, but then government policies to stimulate the economy cause the unemployment rate to fall to 4%, a level below the natural rate level The economy then moves along PC1 to point 2, with inflation rising above 2%, say to 3.5% Expected inflation will then rise as well, so the expectations-augmented Phillips curve will shift upward from PC1 to PC2 Continued efforts to stimulate the economy and keep the unemployment rate at 4%, below the natural rate level, will cause further increases in the actual and expected inflation rates, causing the expectations-augmented Phillips curve to shift upward to PC2 and to point 3, where inflation is now 5% When will the expectations-augmented Phillips curve stop rising? Only when unemployment is back at the natural rate level, that is, when U = Un = 5% Suppose this happens when inflation is at 10%; then expected inflation will also be at 10% because inflation has settled down to that level, with the expectations-augmented Phillips curve at PC3 in Figure 11.2 The economy will now move to point 4, where π = πe = 10%, and unemployment is at the natural rate, U = Un = 5% We thus see that in the long run, when the expectations-augmented Phillips curve is no longer shifting, the economy will be at points like and The line connecting these points is thus the long-run Phillips curve, which we mark as LRPC in Figure 11.2 Figure 11.2 leads us to three important conclusions: There is no long-run trade-off between unemployment and inflation because, as the vertical long-run Phillips curve shows, a higher long-run inflation rate is not associated with a lower level of unemployment There is a short-run trade-off between unemployment and inflation because with a given expected inflation rate, policy makers can attain a lower unemployment rate at the expense of a somewhat higher than the expected inflation rate, as at point in Figure 11.2 There are two types of Phillips curves, long-run and short-run The expectations-augmented Phillips curves—PC1, PC2, and PC3—are actually short-run Phillips curves: they are drawn for given values of expected inflation and will shift if deviations of unemployment from the natural rate cause inflation and expected inflation to change The Phillips Curve After the 1960s As Figure 11.2 indicates, the expectations-augmented Phillips curve shows that the negative relationship between unemployment and inflation breaks down when the unemployment rate remains below the natural rate of unemployment for any extended period of time This prediction of the Friedman and Phelps analysis turned out to be exactly right Starting in the 1970s, after a period of very low unemployment rates, the negative relationship between unemployment and inflation, which was so visible in the 1950s and 1960s, disappeared, as we can see in panel (b) of Figure 11.1 Not surprisingly, given the brilliance of Friedman and Phelps’s work, they were both awarded Nobel Prizes The Modern Phillips Curve With the sharp rise in oil prices in 1973 and 1979, inflation jumped up sharply (see panel (b) of Figure 11.1) and Phillips-curve theorists realized that they had to add one more feature to the expectations-augmented Phillips curve Recall from Chapter that supply shocks are shocks to supply that change the amount of output an economy can www.downloadslide.com 286 Part four • Business Cycles: The Short Run produce from the same amount of capital and labor These supply shocks translate into price shocks, that is, shifts in inflation that are independent of tightness in labor markets or expected inflation For example, when the supply of oil was restricted following the war between the Arab states and Israel in 1973, the price of oil more than quadrupled and firms had to raise prices to reflect their increased costs of production, thus driving up inflation Price shocks also could come from a rise in import prices or from cost-push shocks, in which workers push for wages higher than productivity gains, thereby driving up costs and inflation Adding price shocks (ρ) to the expectations-augmented Phillips curve leads to the modern form of the short-run Phillips curve: π = πe - ω 1U - Un2 + ρ (2) The modern, short-run Phillips curve implies that wages and prices are sticky The more flexible wages and prices are, the more they, and inflation, respond to deviations of unemployment from the natural rate; that is, more flexible wages and prices imply that the absolute value of ω is higher, which implies that the short-run Phillips curve is steeper If wages and prices are completely flexible, then ω becomes so large that the short-run Phillips curve is vertical, and it becomes identical to the long-run Phillips curve In this case, there is no long-run or short-run trade-off between unemployment and inflation The Modern Phillips Curve with Adaptive (Backward-Looking) Expectations To complete our analysis of the Phillips curve, we need to understand how firms and households form expectations about inflation One simple way of thinking about how firms and households form their expectations about inflation is to assume that they so by looking at past inflation The simplest assumption is: πe = π-1 where π-1 is the inflation rate in the previous period This form of expectations is known as adaptive expectations or backward-looking expectations because expectations are formed by looking at the past and therefore change only slowly over time.5 Substituting π-1 in for πe in Equation yields the following short-run Phillips curve: π = π-1 - ω 1U - Un2 + ρ (3) Inflation = Expected - ω * Unemployment + Price Inflation Gap Shock This form of the Phillips curve has two advantages over the more general formulation in Equation First, it takes on a very simple mathematical form that is convenient to use Second, it provides two additional, realistic reasons why prices might be sticky 5An alternative, modern form of expectations makes use of the concept of rational expectations, where expectations are formed using all available information, and so may react more quickly to new information We discuss rational expectations and their role in macroeconomic analysis in Chapter 21 www.downloadslide.com Chapter 11 • Aggregate Supply and the Phillips Curve 287 One reason comes from the view that inflation expectations adjust only slowly as inflation trends change: inflation expectations are therefore sticky, which results in some inflation stickiness Another reason is that the presence of past inflation in the Phillips curve formulation can reflect the fact that some wage and price contracts might be backward-looking, that is, tied to past inflation trends, and so inflation might not fully adjust to changes in inflation expectations in the short run There is, however, one important disadvantage of the adaptive-expectations form of the Phillips curve in Equation 3: it takes a very mechanical view of how inflation expectations are formed More sophisticated analysis of expectations formation has important implications for the conduct of macroeconomic policy, as we will see in Chapter 21 For the time being, we will make use of the simple form of the Phillips curve with adaptive expectations, keeping in mind that the π-1 term represents expected inflation There is another convenient way of looking at the adaptive-expectations form of the Phillips curve By subtracting π-1 from both sides of Equation 3, we can rewrite it as follows: ∆π = π - π-1 = -ω 1U - Un2 + ρ (4) Written in this form, the Phillips curve indicates that a negative unemployment gap (tight labor market) causes the inflation rate to rise, that is, accelerate This relationship is why the Equation version of the Phillips curve is often referred to as an accelerationist Phillips curve With this formulation, the term Un has another interpretation Since inflation stops accelerating (changing) when the unemployment rate is at Un, we also refer to this term as the non-accelerating inflation rate of unemployment or, more commonly, NAIRU The Aggregate Supply Curve To complete our aggregate demand and supply model, we need to use our analysis of the Phillips curve to derive an aggregate supply curve, which represents the relationship between the total quantity of output that firms are willing to produce and the inflation rate In the typical supply and demand analysis, we have only one supply curve, but this is not the case in the aggregate demand and supply framework We can translate the short- and long-run Phillips curves into short- and long-run aggregate supply curves We begin by examining the long-run aggregate supply curve We then derive the short-run aggregate supply curve and see how it shifts over time as the economy moves from the short run to the long run Long-Run Aggregate Supply Curve What determines the amount of output an economy can produce in the long run? As we saw in Chapter 3, the key factors that determine long-run output are available technology, the amount of capital in the economy, and the amount of labor supplied in the long run, all of which are unrelated to the inflation rate The level of aggregate output supplied at the natural rate of unemployment is often referred to as the natural rate of output However, the natural rate of output is more commonly referred to as potential output, a term we encountered in Chapter 8, because it is the level of production that an economy can sustain in the long run www.downloadslide.com 288 Part four • Business Cycles: The Short Run Mini-lecture Figure 11.3 Long- and ShortRun Aggregate Supply Curves Inflation Rate (percent) LRAS AS The amount of aggregate output supplied at any given inflation rate is at potential output in the long run, so that the long-run aggregate supply curve LRAS is a vertical line at Y P The short-run aggregate supply curve, SRAS, is upward sloping because as Y rises relative to Y P , labor markets get tighter and inflation rises SRAS intersects LRAS at point 1, where current inflation equals the expected inflation 3.5% 2% Y P = 10 11 Aggregate Output, Y ($ trillions) The preceding reasoning indicates that because the long-run Phillips curve is vertical, the long-run aggregate supply curve is vertical as well.6 Indeed, the long-run aggregate supply curve (LRAS) is vertical at potential output, denoted by Y P, say, at a quantity of $10 trillion, as drawn in Figure 11.3 Another way to think about the vertical long-run aggregate supply curve is that when wages and prices fully adjust, there is a decoupling of the relationship between unemployment and inflation The classical dichotomy that we discussed in Chapters and indicates that what happens to the price level is divorced from what is happening in the real economy Short-Run Aggregate Supply Curve We can translate the modern Phillips curve into a short-run aggregate supply curve by replacing the unemployment gap 1U - Un2 with the output gap we discussed in Chapter 8, the difference between output and potential output 1Y - Y P2 To this, we need to make use of a relationship between unemployment and aggregate output that was discovered by the economist Arthur Okun, once the chairman of the Council of Economic Advisors and later an economist with the Brookings Institution.7 Okun’s law describes the negative relationship between the unemployment gap and the output gap 6Higher inflation can make for a less efficient economy and thus lead to a decline in the quantity of output actually produced In this case, the long-run aggregate supply curve might have a downward slope This insight does not change the basic lessons from aggregate demand and supply analysis in any significant way, so for simplicity we will assume that the long-run aggregate supply curve is vertical 7Arthur M Okun, “Potential GNP: Its Measurement and Significance,” in Proceeding of the Business and Economics Section: American Statistical Association (Washington, D.C.: American Statistical Association, 1962), pp 98–103; reprinted in Arthur M Okun, The Political Economy of Prosperity (Washington, D.C.: Brookings Institution, 1970), pp 132–145 www.downloadslide.com Chapter 11 • Aggregate Supply and the Phillips Curve 289 Okun’s Law Okun’s law states that for each percentage point that output is above potential, the unemployment rate is one-half of a percentage point below the natural rate of unemployment Algebraically, it can be written as follows:8 U - Un = -0.5 * 1Y - Y P2 (5) Another way of thinking about Okun’s law is that a one percentage point increase in output leads to a one-half percentage point decline in unemployment.9 Figure 11.4 shows that the evidence for Okun’s law is quite strong because there is a tight negative relationship between the percentage change in unemployment and real GDP growth Figure 11.4 Quarterly Change in Unemployment Rate (percentage points) Okun’s Law, 1960–2013 The plot of the percentage point change in the unemployment rate versus the GDP growth rate reveals a linear relationship, represented by the solid line with a slope of - 12 Source: Unemployment, quarterly, 1960–2013 and real GDP growth, quarterly, 1960–2013 Bureau of Labor Statistics and Bureau of Economic Analysis 2.0% 1.5% 1.0% 0.5% 0.0% –0.5% –1.0% –1.5% –3.0% –2.0% –1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% Quarterly GDP Growth (percentage points) output gap, Y - Y P, in Okun’s law is most accurately expressed in percentage terms, so the units of Y and Y P would normally be in logs However, to keep the algebra simple in this and later chapters, we will treat Y and Y P as levels and not logs both in the Okun’s law equation and in the short-run aggregate supply curve developed here 8The 9To see this algebraically, take the differences of Equation and assume that Un remains constant (a reasonable assumption because the natural rate of unemployment changes very slowly over time) Then, %∆U = - 0.5 * 1%∆Y - %∆Y P2 where %∆ indicates a percentage point change Since potential output grows at a fairly steady rate of around three percent a year, %∆Y P = 3%, we can also write Okun’s law as follows: or %∆U = - 0.5 * 1%∆Y - 32 %∆Y = - 2.0 * %∆U Hence we can state Okun’s law in the following way: for every percentage point rise in output (real GDP), unemployment falls by one-half of a percentage point Alternatively, for every percentage point rise in unemployment, real GDP falls by two percentage points www.downloadslide.com 290 Part four • Business Cycles: The Short Run Why is the rate of decline in unemployment only half the rate of increase in output? When output rises, firms not increase employment commensurately with the increase in output, a phenomenon that is known as labor hoarding Rather, they work employees harder, increasing their hours Furthermore, when the economy is expanding, more people enter the labor force because job prospects are better, and so the unemployment rate does not fall by as much as employment increases Deriving the Short-Run Aggregate Supply Curve Using the Okun’s law Equation to substitute for U - Un in the short-run Phillips curve Equation yields the following: π = πe + 0.5 ω 1Y - Y P2 + ρ Replacing 0.5 ω by γ, which describes the sensitivity of inflation to the output gap, produces the short-run aggregate supply curve: π = πe + γ 1Y - Y P2 + ρ (6) Inflation = Expected + γ * Output + Price Inflation Gap Shock As we did in the Phillips curve analysis, we need to make an assumption about how expectations of inflation are formed, and again we will assume that they are adaptive so that πe = π-1 The short-run aggregate supply curve then becomes π = π-1 + γ1Y - Y P2 + ρ (7) Let’s assume that inflation last year was at 2%, so that π-1 = 2%, and that there was no supply shock, so ρ = 0, and potential output Y P = $10 trillion Let’s also assume that the parameter γ, which describes how inflation responds to the output gap, equals 1.5 Then we can write the short-run aggregate supply curve as follows: π = + 1.5 1Y - 102 (8) If Y is at potential output, Y P = $10 trillion, then the output gap, Y - 10, is zero Equation then shows that at a level of output of $10 trillion, at which the output gap is zero, π = 2% We mark this level as point on the short-run aggregate supply curve, AS, in Figure 11.3 on page 288 Note that the short-run supply curve intersects the long-run supply curve at the point at which the 2% current inflation rate equals 2% expected inflation Now suppose that aggregate output rises to $11 trillion Because there is a positive output gap (Y = $11 trillion Y P = $10 trillion), Equation indicates that inflation will rise above 2% to 3.5%, marked as point The curve connecting points and is the short-run aggregate supply curve, AS, and it is upward sloping The intuition behind this upward slope comes directly from Okun’s law and Phillips curve analysis When Y rises relative to Y P and Y Y P, Okun’s law indicates that the unemployment rate falls With the labor market tighter, the short-run Phillips curve tells us that firms will raise their wages at a more rapid rate Firms will therefore also raise their prices at a more rapid rate, causing inflation to rise Our discussion of how the short-run aggregate supply curve works indicates that there is a close relationship between the Phillips curve and the short-run aggregate supply curve, as is discussed in the box, “The Relationship of the Phillips Curve and the Short-Run Aggregate Supply Curve.” www.downloadslide.com I-9 Interest rates, 502–506, 503f, 505f equilibrium and, 264f, 266–267, 267f for Federal Home Loan Mortgage Corporation, 40 and inflation, 116, 117f measurement of, 40–42, 41n6, 42f money market and, 263–267, 264f, 267f, 267n4, 268f types of, 40, 40f for U.S Treasury bills, 40, 117 Interest rates, nominal federal funds rate and, 252 real and, 41–42, 42f, 43, 46, 49 Interest rates, real consumer spending and, 82–83, 83f consumption expenditure and, 233 falling, 86, 87 for investments, 235 net export and, 235–236, 236n3 nominal and, 41–42, 42f, 43, 46, 49 planned investment spending and, 234 rising, 87 world, 89, 91–92 International Monetary Fund (IMF), 188 Interstate Highway System, U.S., 180 Intertemporal budget constraint in action, 495–497, 495n3, 496f optimization of, 499–500, 500f preferences of, 498–499 present discounted value and, 497–499, 498f Intertemporal choice, 518 consumption and theory of, 495 model, 500–506, 501f, 503f, 505f Intertemporal marginal rate of substitution, 499 Intuition IS curve and, 238–239 behind money multiplier, 138–139, 139n3 results, 357 Inventories, 22 Inventory investment component, 232–233 GDP and, 22 holding, 534–535 theory of, 535–536 Investment, 49, 80, 81f, 97–100 bank, 373 “bathtub model” and, 152, 153, 154f business fixed, 523 capital government, 438 categories, 24–26, 25t closed economy, changes in saving and, 84–89, 86f, 87n2, 88f closed economy, saving and, 81–84, 83f curve, 88–89, 88f definition of, 26 depreciation and, 150–151, 151f determinants of, 532t–534t diagram, saving-, 83f, 84, 240–241, 241f expenditure, 24–26, 25t fixed, 25t, 26, 233 function, 149–150, 150f, 150n3, 151f GDP and, 24–26, 25t, 27–28, 28f levels, 83f, 84 neoclassical theory on, 524–534, 527f, 528f, 529f, 530f, 532t–534t net foreign, 77 open economy, saving and, 89 planned, 235 real interest rates for, 235 residential, 25t, 26, 523, 537–538, 538f rise in, 88–89, 88f small open economy, changes in saving and, 92–95, 93f, 94f, 95f spending, 523–524, 524f tax credit, 89 See also Government investment; Inventory investment Investment, autonomous analysis, 83f, 84 changes in, 87f, 88–89 as component, 235 monetary policy and, 300, 300t, 301 spending, 246 Investment spending, planned, 232 fixed, 233 inventory, 233–234 real interest rates and, 234 Iraq War (2002), 433 IRAs See Individual Retirement Accounts Ireland, 385, 406, 447, 448 IS curve, 247 comprehension of, 238–241, 240f, 240n7, 241f intuition and, 238–239 with numerical example, 239 planned expenditure and, 231–232 saving-investment diagram and, 240–241, 241f shift in, 241–246, 242f, 243f, 244f, 246t, 259–261, 260f, 261n3, 262f Italy, 161, 448 Japan, 161 convergence and, 154–155, 155f lost decade of, 414–415 per capita income of, 53–54, 54t, 147–148, 148f post-war, 156 Jay Cooke & Company, 218, 396 Jewelry, 103 Job creation, 17 Johnson, Lyndon B., 281, 283 Jorgenson, Dale, 524 J.P Morgan, 408 Katz, Lawrence, 181, 560 Kennedy, John F., 281, 283 Kenya, 147f, 148 Keynes, John Maynard, 221, 223, 231, 232, 235, 263, 273, 279, 506 Keynesian model, new, 612–615, 613f, 624–627 basis of, 572, 601–602 building blocks of, 602–605, 602f comparison of, 611 fluctuations in, 605–606, 606f objections to, 606–607 Keynesian model, traditional, 207, 226, 607, 612, 613f, 615, 624–627 comparison of, 611 on consumption, 506–507 on economic fluctuations, 221–222 long run and, 222–223, 222t short run and, 222–223, 222t theories of money demand, 273–275, 274n1 King, Robert, 384 Klenow, Peter, 225 Kleptocracies, 187 Knickerbocker Trust Company, 218, 396 Kremer, Michael, 197 Krueger, Alan, 560 Kuznets, Simon, 19 Kydland, Finn, 578 Labor costs, 60 factor prices, demand for capital and, 60–62, 60n7–9, 61n10 factor prices and supply of capital, 62, 63f growth of, 66t www.downloadslide.com I-10 Labor (cont.) hoarding, 600 input, 56, 56f levels, 160n8 measurement of, 51 productivity of, 51–52, 53n3, 65n11, 167n10 Romer model and, 189–190 unit of, 65n11 See also Marginal product of labor Labor demand, 60–62, 60n7–9, 61n10 changes in, 549–550, 550f, 550n3 Labor force excluded from, 37 types of, 37–38 women in, 551–554, 551f, 552f, 553f, 554f Labor-force participation rate, 38–39, 39f Labor income concept of real, 64–65 share, 65 Labor market, U.S demand curve and, 547, 548–549, 548f developments in, 544–546, 545f, 546f, 547f equilibrium in, 549 real wages for, 546, 547f supply curve and, 547, 549, 549n1–2 unemployment rate for, 546, 547f Labor supply capital supply and factor prices, 62, 63f changes in, 550–551, 551f Laffer, Arthur, 445–446 Lags, 343–345 Land as collateral, 380–381 legal title to, 381 Latin America, 16, 147–148, 147f Law common, 184, 185 of one price, 463–464 reading of, 186 Lawyers, 185 Legal system economic growth and, 185 effective, 178 enforcement of contracts within, 184–185, 184t origins of, 184–185, 184t property rights and, 183–185, 184t resouces for, 184–185 Legislative lag, 343 Lehman Brothers, 216, 319, 320, 396, 407 Leisure, 549 Lender-savers, 373, 373f, 374, 396 Leverage cycle, 393 Levine, Ross, 384 Liabilities currency in circulation as, 125–126 definition of, 373 monetary, 125–126 primary, 375, 375t reserves as, 125–126 LIBOR See London Inter-Bank Offered Rate Life -cycle consumption function, 511–515, 514f -cycle hypothesis, 511–515, 514f expectancy, 23 Liquidity constraints, 452, 504–506, 505f money demand and, 263 of other assets, 276 preference framework, 263, 269 preference function, 263, 275 preference theory, 263 provision, 359, 359f trap, 277, 277n3 Liquidity preference, theory, 263 Literacy, 23 Loan car, 119–120 obtaining, 381 private, 377 Loans, discount as asset, 125, 126, 128 effects of, 128–129 Loan-to-value ratio, 403 London Inter-Bank Offered Rate (LIBOR), 40 Lucas, Robert, 146, 576 Lucas critique consumption function and, 577 econometric policy evaluation and, 576 of policy evaluation, 576–581 Maastricht Treaty, 329 Macroeconomic analysis, 575–576 Macroeconomic data interpretation of, 5–9, 5f, 6f, 7f, 8f, 9f measurement of, 19–20 Macroeconomic models, 4–5, 4f, 24 Macroeconomic policy during 1960s, 283 issues, 9–13, 10f, 11f, 12f, 16–17 objectives of, 327–330, 327n1, 328n2, 329n4 rule and, 13 Macroeconomics agreement on, 619–624 disagreement on, 624–628 finance and, 370–371 practice of, 3–9, 4f, 5f, 6f, 7f, 8f, 9f, 15–16 study of, summary on, 15 time horizons in, 221–223, 222t Macroeconomic variables, 226 business cycle and, 211–216, 212f, 213f, 214f, 215f, 216f, 217f, 218f financial variables and, 215, 215f, 216f, 217f, 218f inflation and, 212, 214f real GDP and, 211–212, 213f unemployment and, 212, 214f Managed float regime, 477 Mandate-consistent inflation objective, 588 Marginal product decline of, 55–56, 55f, 56f diminishing, 55 Marginal product of capital (MPK) calculation for, 57, 57n5 indication of, 55–56, 55f real rental price of capital and, 61, 61n10 supply shock and, 58f, 59, 59n6 Marginal product of labor (MPL) calculation for, 57, 57n5 indication of, 56, 56f real wage rate and, 61, 61n10, 64–65 supply shocks and, 58f, 59, 59n6 Marginal propensity to consume, 233, 506 Marginal rate of substitution, 499 Marginal rate of substitution, intertemporal, 499 Market -clearing assumption, 601 financial, 216, 405–406 operations, open, 105 power, 223 value of goods and services, 20–22 See also Goods market equilibrium www.downloadslide.com I-11 Market equilibrium, 152 concept of, 62 factor prices and, 62–64, 63f Marshall Plan, 189, 189n13 Massachusetts Institute of Technology (MIT), 182 McCallum, Bennet, 576, 578 Measuring Business Cycles (Burns & Mitchell), 207 Medicaid, 434 Medicare, 26, 427, 434 Meltzer, Alan, 578–579 Merrill Lynch, 407 Mexico, 147f, 148 Microcredit, 374 Microeconomic models, 3–5, 4f Microeconomics rationale, 575 study of, Mihov, Ilian, 225 MIT See Massachusetts Institute of Technology Mitchell, Wesley, 207, 209 Monetary aggregates, 121 Fed and, 106–107, 107t, 108f M1, 106–107, 107t, 108f M2, 106–107, 107t, 108f measures of, 107t usage of, 108f Monetary base, 141 control of, 126–129 Fed’s, 125–126 nonborrowed, 129, 133 U.S Treasury’s, 125–126 A Monetary History of the United States (Friedman & Schwartz), 579 Monetary neutrality, 350 Monetary policy, 269, 364 autonomous, 300, 300t autonomous consumption expenditure and, 300, 300t, 301 autonomous easing of, 254, 255f, 256 autonomous investment and, 300, 300t, 301 autonomous net exports and, 300, 300t, 301 autonomous tightening of, 254 equilibrium real interest rate and, 330–331, 331n5, 332f Fed and, 251–252 financial friction and, 300, 300t, 302 government purchases and, 300, 300t, 301 management of, 12 nonconventional, 358–359, 358f shift in Japan’s, 362–363, 363f taxes and, 300, 300t, 301 Taylor principle and, 253–254, 253n1, 254n2 at zero lower bound, 355–363, 356f, 358f, 359f, 361f zero lower bound and, 355–363, 356f, 358f, 359f, 361f, 364 Monetary policy, inflationary causes of, 350–354, 351f, 353f Great Inflation and, 351f, 353f, 354–355, 354f Monetary policy curve (MP), 205 inflation rate and, 252, 253f movements along, 253f, 254–255, 255f, 256f shifts in, 254, 255f, 256, 256f, 261, 266f Taylor Rule and, 335f, 342f, 346–347, 347f upward slope of, 253–254, 253n1, 254n2 usage of, 251 Monetary union, 480–481 Money, 121 balances, real, 263 demand curve for, 264, 264f forms of, 103 functions of, 102–103 government-issued, 449–450, 449n13 growth rates and inflation, 114, 114f high-powered, 126 meaning of, 102 measurement of, 106–108, 107t, 108f as medium of exchange, 102–103 neutrality of, 112 printing, 449 quantity of, 101 quantity theory of, 109–114, 109n3, 113f, 114f simple curve for, 264f, 265 as stock, 102 as store of value, 103 as unit of account, 103 velocity of, 109–110, 109n3 wealth and, 102 Money demand, 279 evidence on, 276–278, 277n3, 277t factors, 110, 276 interest rates and, 277, 277n3 Keynesian theories of, 273–275, 274n1 liquidity and, 263 portfolio theories of, 275–276, 275n2, 279 precautionary motive of, 273–274 speculative motive of, 273–274 stability of, 278 transaction motive of, 273 Money market equilibrium in, 264f, 265 interest rates and, 263–267, 264f, 267f, 267n4, 268f Money multiplier concept, 136–137 deriving, 137–138 intuition behind, 138–139, 139n3 Money supply control of, 104–106, 104f determination of, 133–136, 134t, 135f, 136t process, 125–140, 132t, 134t, 135f, 136t, 139n3 quantitative easing and, 135–136, 135f, 136t responses, 139–140 Monitoring, 378 Monopoly, 223 Moral hazard, 376, 392, 398–399, 398f Mortgage loans, 381 subprime, 400 Mortgage market, subprime collapse of, 207 problems with, 401 MPK See Marginal product of capital MPL See Marginal product of labor Mugabe, Robert, 115, 187 Multiplier expenditure, 441–442 fiscal, 443–444, 444f tax, 440–442, 441f, 441n8 See also Money multiplier Mutual funds, 375, 375t Myopia, 45 The Mystery of Capital (De Soto), 186, 380 NAIRU See Non-accelerating inflation rate of unemployment Napoleonic Code, 184 National Bureau of Economic Research (NBER), 209, 209n2 National Central Banks (NCBs), 106 www.downloadslide.com I-12 National income to capital owners, 64–68, 66t, 67f, 69, 70 distribution of, 64–68, 66t, 67f, 69–71 GDP and, 30t identity, 24–26, 25t measurement of, 30–31, 30t to workers, 64–68, 66t, 67f, 69, 70 National income accounting fundamental identity of, 20 government spending and, 24–26, 25t invention of, 19 system, 20 National Income and Product Accounts, 19 National Institutes of Health, 182 National saving, 80, 81f, 451 calculation of, 75 policies to stimulate, 76 rate, 75–76, 159 reduction in, 438 National Science Foundation, 182 NBER See National Bureau of Economic Research NCBs See National Central Banks Neoclassical synthesis, new, 619 Neoclassical theory on investment, 524–534, 527f, 528f, 529f, 530f, 532t–534t Net capital outflow, 77–78, 77n1, 92 Net capital outflow identity, 77–78, 77n1, 80, 81f Net domestic product, 30 Net export, 232 autonomous, 236, 237, 237n4, 245, 300, 301t, 302 function, 236 GDP and, 24–25, 25t, 27, 27n2 imports and, 27, 27n2 real interest rates and, 235–236, 236n3 U.S trade deficits and, 27–28, 28f, 77 Net factor income, 30, 30t Net foreign assets, 78–79, 78f Net worth, 375, 375t New York Times, 344 New Zealand, 184, 329 Nigeria oil of, 50 per capita income of, 147–148, 147f Nixon, Richard, 580 Nominal anchor, 593 benefits of, 582 commitment to, 623 role of, 582–587, 583f, 585f, 586f Non-accelerating inflation rate of unemployment (NAIRU), 287 North, Douglass, 183 North America, 147–148, 147f Northern Rock, 405–406 Norway, 23 Obama, Barack, 87, 344, 427, 433, 440, 442, 560 Objects, 179 Objects, rival, 179 OECD See Organization of Economic Cooperation and Development Office of the Controller of the Currency, 408n8 Ohio Life Insurance and Trust Company, 396 Oil embargo, 313 of Nigeria, 50 price shocks, 585–587, 585f, 586f shocks, 66–68, 67f, 354 wealth, 50 Okun’s law, 288–291, 288f, 289f, 289n8–9 OPEC See Organization of the Petroleum Exporting Countries Open market purchase, 127 sale, 127 Open market operations bank system and, 127–128 factors of, 105 Fed’s, 127 securities and, 126 Optimal forecast, 574 Organization of Economic Cooperation and Development (OECD), 23, 154 Organization of the Petroleum Exporting Countries (OPEC), 59, 313 Originate-to-distribute, 401 Output, 87 aggregate, 85, 112 capital and, 55–56, 55f, 56f domestic, 27n2 gap, 209, 293–294, 294f levels, 156, 158 natural rate of, 287 per capita income, 195, 195t potential, 208–209, 208t technology as production, 178–179 value of, 20–21 Parmalat, 382 Patents, 181, 182–183 Payment interest, 27, 31 technology, 27, 273 PCE See Personal consumption expenditure deflator Peg, crawling, 482 Pegging advantages of, 482–483 disadvantages of, 483–484 foreign exchange rate, 482–484 Pension funds, 375, 375t People’s Bank of China, 322 Percentage change method, inflation rate and, 36–37 Permanent income hypothesis, 508, 509–510, 509f, 510f Personal consumption expenditure, 24–25, 25t, 27–28, 28f, 43 Personal consumption expenditure deflator (PCE), 34, 36f, 43 Peru, 186 Phelps, Edmund, 284 Philippines, 380 Phillips, A W., 281 Phillips curve, 205, 295 after 1960s, 284f, 285 accelerationist, 287 analysis, 282–283, 282f analysis, Friedman-Phelps, 283–285, 283n3–4, 284f concept, 281–282 expectations-augmented, 284–285, 284f long-run, 284f, 285 modern, 285–287, 286n5 short-run, 285 short-run aggregate supply curve and, 291 tradeoff, 283 Policy conduct, 577–579 discretionary, 13 implementation, 343–345 key, rule-determined, 13 trilemma, 479–480, 480f Policy makers, 578, 593 activist, 343, 344–345 debate of, 344–345 economic activity and, 343–344 nonactivist, 343, 344–345 www.downloadslide.com I-13 Population engaged in R&D, 192–193, 193f increase in, 195, 195f Population growth changes in, 161 living standards and, 196–197, 196f policies limiting, 163 Real GDP and, 161–163, 162f, 163f in Solow growth model, 159–163, 160f, 160n8, 162f, 163f steady state and, 159–161, 160f, 160n8 “Pork” spending, 438 Portfolio theories of money demand, 275–276, 275n2, 279 Portugal, 154–155, 155f Poverty, 50, 189n12 See also Countries, poor PPP See Theory of purchasing power parity Prescott, Edward, 578 Price changing, 223–224 controls, 313 of currency, 235–236, 236n3 deflator for GDP, implicit, 33–34, 33n4, 36f, 43 as flexible, 111 fluctuation of, 119 of goods and services, 33 inflation and, 7–9, 8f, 9f level, 32 market, 59–60 relative, 118–119, 120 setting, staggered, 224 shocks, 292, 293f stability, 329, 620 See also Factor prices; Sticky prices Price index inflation and, 33 inflation rate and, 36, 36f See also Consumer price index Prime rate, 40 Principal-agent problems, 401 Production, 49 approach to GDP, 20–24, 24f, 43, 44 changes in R&D, 194, 194f conventional inputs, 179 factors of, 50–51 function, 51–52, 190 function and Romer model, 190 of goods and services, 20, 21 inputs, 178 just-in-time, 534 smoothing, 535 tax on, 430 total, 20 Production, aggregate, 50–59, 51n1, 53n3, 54t, 55f, 56f, 58f, 69, 70 Production function, aggregate, 69, 70 application of, 52–54, 53n3, 54t changes in, 57–59, 58f description of, 51–52 supply shocks and, 57–59, 58f Production function, Cobb-Douglas aggregate, 148 characteristics of, 54–57, 55f, 56f, 69 general form of, 51, 51n1 properties of, 65 Productivity, 199 of capital, 51–52 description of, 51 exogenous, 178 growth in Solow growth model, 164–165, 164f growth of, 66t of labor, 51–52, 53n3, 65n11 policies to promote, 179–183 total factor, 51, 167n10 Profits, 30, 30t Property rights, 103, 178, 199 grabbing hand and, 186–187 institutions and, 183–189, 184t, 186n6, 188n9–11, 189n12–14 legal system and, 183–185, 184t obstacles to, 185–187, 186n6 The Purchasing Power of Money (Fisher), 109 Quantitative easing, 360, 360n12, 410–412 Quantity theory, 121 inflation and, 112–114, 113f, 114f in long run, 113–114, 113f of money, 109–114, 109n3, 113f, 114f price level and, 111–112 in short run, 114, 114f test, 113–114, 113f, 114f Random walk hypothesis, 515–516, 518 Ratio capital-labor, 149 dependency, 433 employment, 38–39, 39f, 544–546, 545f employment-to-population, 544 loan-to-value, 403 sacrifice, 612, 613f Ratio, required reserve changes in, 133 factors of, 126 Rational expectations, 593 concept of, 286n5, 572 policy making and, 573–576, 574n1 revolution, 576 theory, 575–576 R&D See Research and development Reagan, Ronald, 93, 94f, 432 Real estate, 381 Recession, 537 1973–1975, 212 1981–1982, 212 2001, 209 consumer spending during, 212 representations of, 5–6, 5f start of, 209 See also Great Recession Recognition lag, 343 Regulation of financial sector, 381–384 macroprudential, 418 prudential, 384 Regulatory forbearance, 415, 415n9 Reinhart, Carmen, 435 Rent, housing, 21, 30 Rental cost of capital, real concept of, 60–62 notation for, 60n8 Rental price of capital, real concept of, 60–62, 60n8 MPK and, 61, 61n10 negative supply shock’s effect on, 66–68, 67f Repurchase agreements (repos), 404 Research and development (R&D) encouragement of, 181–183 government purchases on, 181–182 patents and, 181, 182–183 population engaged in, 192–193, 193f production changes in, 194, 194f tax incentives for, 181, 182 Reserve Bank of New Zealand, 329 Reserves bank, 126–127 borrowed, 126, 129, 133 excess, 126, 132, 134 Fed, 264f, 265 international, 475 as liabilities, 125–126 required, 126 www.downloadslide.com I-14 Restrictive covenants, 379 Retirement benefits, 29, 30t Returns expected, 275, 487 on saving, 76 to scale, constant, 54 Revaluation, 479 Revenue from goods and services, 60 from seignorage, 450 tax, 31, 73, 75 Ricardian equivalence, 454 bottom line on, 452–453 government budget deficits and, 450–453 implications of, 451 objections to, 452 Risk averse, 275 currency and, 276 definition of, 275 hazard, 376 Rogoff, Kenneth, 435, 589 Rolls-Royce, 78 Romer, Christine, 442 Romer, Paul, 189 Romer model, 189n14, 199 factors affecting, 190–198, 193f, 194f, 195f, 196f, 198f labor and, 189–190 production function and, 190 production of technology and, 190–191, 191f saving and, 197–198, 198f Roosevelt, Franklin Delano, 398 Royal Dutch Shell, 382 Ruble, 108 Rule adoption of, 577 case for, 579 constant-money-growth-rate, 578–579 -determined policy, 13 institutions, 624 macroeconomic policy and, 13 types of, 578–579 See also Taylor Rule Russia, 108 Rwanda, 6, 6f Sachs, Jeffrey, 188, 188n9 St Louis Federal Reserve FRED database, 17–18, 40, 588 Salaries employee, 28–29, 30t non, 65, 66t Samuelson, Paul, 215, 281, 283 Sargent, Thomas, 576 Saving, 49, 97–100 changes in, 85–88, 86f closed economy, changes in investment and, 84–89, 86f, 87n2, 88f closed economy, investment and, 81–84, 83f domestic, 92–93, 93f government policies to stimulate, 76 -investment diagram, 83f, 84 open economy, investment and, 89 policies, 517 private, 74, 75f, 87n2 returns on, 76 small open economy, changes in investment and, 92–95, 93f, 94f, 95f uses of, 77–78, 77n1 wealth and, 73–80, 75f, 79f, 80f, 81f See also Government saving; National saving Saving-investment diagram, 240–241, 241f Saving rate, 507 changes in Solow growth model, 156–159, 156n5, 157f, 158f, 159n6 cross-country comparisons of, 11, 11f government, 73 national, 75–76, 159 private, 74, 75f U.S., 10–11, 10f, 17, 73, 75f, 80 of workers, 149–150, 150f SCAP See Supervisory Capital Assessment Program Schleifer, Andrei, 187 Schwartz, Anna, 579 Screening, 378 Securities as assets, 125, 126–127 markets, 379–380 mortgage-backed, 400 open market operations and, 126 purchase of, 132 sale of, 373 Securities and Exchange Commission, U.S (SEC), 381–382 Securitization, 400 Seignorage currency, 449, 449n14 revenue from, 450 Seko, Mobutu Sese, 188 Self-correcting mechanism, 364 disappearance of, 357, 358f of economy, 307, 317 Self-employed, 28–30, 30t September 11, 2001 terrorist attacks, 310 Services, 25, 25t Services, goods and final, 20, 21–22 intermediate, 21–22 market value of, 20–22 newly produced, 20, 23 nonmarket, 21 nontradable, 464 price of, 33 production of, 20, 21 in relationship with CPI, 34–35 revenue from, 60 Shelter, 50 Shinzo Abe, 362 Shocks, 364 energy, 59 natural environment, 59 oil, 66–68, 67f technology, 57 See also Supply shocks Singapore, 169 Social Security, 26 benefits, 35 increases, 434 program, 427 Social Security Administration, 433 Solow, Robert, 14, 148, 281, 283 Solow diagram, 152 Solow growth model, 171 algebra of, 176–177 building blocks of, 148–156, 150f, 150n3, 151f, 153f, 154f, 155f, 155n4 concept, 148 dynamics of, 151f, 152–153, 153f limitations of, 166 population growth in, 159–163, 160f, 160n8, 162f, 163f productivity growth in, 164–165, 164f results of, 165–166 saving rate changes in, 156–159, 156n5, 157f, 158f, 159n6 steady state and, 151–152 Solow residual, 167 business cycle fluctuations and, 599, 600f productivity shocks and, 600–601 www.downloadslide.com I-15 South Korea, 155 economic growth of, 146, 169 Real GDP of (2012), 6–7, 6f Sovereign debt crisis, 433–437, 454 Soviet Union, 386 Spain, 448 Speculative attacks, 483–484 Spending autonomous, 235, 245–246 autonomous investment, 246 for capital goods, 26 categories of, 24 components of GDP, 27–28, 28f education, 181 investment, 523–524, 524f “pork,” 438 types of, 232 U.S., 13 See also Consumer spending; Government purchases; Investment spending Stabilization policy active, 13 of economic activity, 328, 328n2, 330–340, 331n5, 332f, 333f, 334n6–7, 335f, 336f, 337n8, 338f, 339f, 341f, 342f effectiveness of, 626 implications for, 608–611, 609t, 610f importance of, Stagflation, 312 Stagnation, 312 Standard of living within countries, 18 differences in, 50 Standard & Poor’s, 405 Stanford University, 35, 182 Statistical discrepancy, 30, 30n3 statistics See Economic statistics Steady state “bathtub model” of, 152, 153, 154f levels, 156 population growth and, 159–161, 160f, 160n8 Solow growth model and, 151–152 solving, 176–177 summary on, 165–166 Sticky prices, 226 empirical evidence for, 224–225 role of, 222–223, 222t sources of, 223–224 Stiglitz, Joseph, 23 Stock, 103 common, 23 concept of, 23–24, 24f -out avoidance, 535 prices, 215, 215f Stock, capital increase of, 55 level of, 524–525, 529–530, 529f, 530f Stock market crash, 398, 398f, 513, 537 effects on, 66–68, 67f Substitution effect, 503, 503n5 Summers, Larry, 591 Supervision of financial sector, 381–384 prudential, 384 Supervisory Capital Assessment Program (SCAP), 408n8 Supply excess, 62–64, 63f, 264f, 265 negative, 318–319, 318f -siders, 445 See also Aggregate supply Supply curve aggregate demand curve and, 299–303, 300t, 303t factors, 266–267, 267f, 267n4 U.S labor market and, 547, 549, 549n1–2 Supply curve, aggregate, 295, 323 factor, 281 long-run, 287–288, 288f Phillips curve and short-run, 291 shifts in, 291–294, 292f, 293f, 294f short- and long-run, 302–303, 303t short-run, 288–291, 288f, 289f, 289n8–9 Supply shocks, 323 aggregate production function and, 57–59, 58f effect of, 58f, 59, 59n6 negative, 58f, 59, 66–68, 67f, 313, 314f permanent, 314–315, 315f, 315n3, 336–337, 336f, 337n8 positive, 58f, 59, 66–68, 67f, 316–317, 317f temporary, 311–313, 312f, 337–340, 338f, 339f, 341f, 342f types of, 57–59 Supply shocks, aggregate credibility and, 584–585, 585f equilibrium and, 311–319, 312f, 314f, 315f, 316f, 318f negative, 313, 314f permanent, 314–315, 315f, 315n3 positive, 316–317, 317f Survey establishment, 39 household, 39 on workers, 39 Sweden, 184 Swiss Interbank Clearing, 581 Swiss National Bank, 581 Switzerland, 7, 8f, 154, 155f, 581 T-account, 127 Taiwan, 169 Targeting exchange rate, 587 inflation, 587–589 nominal GDP, 589–590 Tariffs, 430 TARP See Treasury Asset Relief Plan Tasmania, 197 Tax, 531, 531n3 breaks, 11, 76 capital gains, 76 changes, 85, 244, 244f code, 89 consumption, 76 corporate, 430 credit, investment, 89 distortions, 118–119, 439 federal income, 430 government purchases and, 236–237, 237n5 higher, 11 incentives, 76 incentives for R&D, 181, 182 income, 31, 73, 75 inflation, 450 monetary policy and, 300, 300t, 301 multiplier, 440–442, 441f, 441n8 national sales, 11, 76 negative, 232, 232n1 personal, 430 on production and imports, 430 rates, income, 76 rebate (2008), 510, 511f revenue, 31, 73, 75 smoothing, 439–440 value-added, 76 wedges, 439 Taylor, John, 253, 403 Taylor principle, 267n4, 622 differences, 346 inflation and, 254, 254n2 monetary policy and, 253–254, 253n1, 254n2 Taylor Rule, 579 equation, 345–346 Fed and, 347–348 www.downloadslide.com I-16 Taylor Rule (cont.) as guide, 345–346 MP and, 335f, 342f, 346–347, 347f in practice, 347–348 Teal Book, 331n5 Tech bubble, 310 Technological spillover, 196 Technology, 199 available, 148 endogenous growth theory and production of, 190–191, 191f excludability and, 179 as ideas, 179 payment, 27, 273 as production output, 178–179 Romer model and production of, 190–191, 191f shocks, 57 Theory agency, 392 economic, 3–4, 4f intertemporal choice, 495 inventory investment, 535–536 neoclassical investment, 524–534, 527f, 528f, 529f, 530f, 532t–534t rational expectations, 575–576 Tobin’s q, 536–537, 540 See also Quantity theory Theory of purchasing power parity (PPP), 464 Third World, 183 This Time It’s Different: Eight Centuries of Financial Folly (Reinhart & Rogoff), 435 Time fixed period of, 23 -inconsistency problem, 578, 622–623 motion studies, 186–187 subscripts, 149–150, 150f Tobin, James, 274, 536–537, 540 Toyota Corolla, 101 Trade, terms of, 460 Trade balance concept, 77, 77n1 decline in, 92 higher, 92 negative, 27, 80, 81f net capital outflow and, 77–78 Trade deficits, U.S dangers of, 13 decline in, 80, 81f goods market equilibrium and, 83f, 88f, 91–92, 91f net export and, 27–28, 28f, 77 Trade imbalances, global dangers of, 13 significance of, Trade surplus of China, 13, 77 goods market equilibrium and, 90–91, 91f Transaction bank, 78 costs, 102–103 forward, 460 motive of money demand, 273 spot, 459–460 Transfer examples of, 232n1 GDP and, 26–27 government income as, 31, 232n1 payments, 428–429 Traveler’s checks, 106, 121 Treasury, U.S monetary base of, 125–126 monetary liabilities of, 125–126 Treasury Asset Relief Plan (TARP), 413 Treasury bills, U.S interest rates for, 40, 117 short-term, 42, 215, 216f Treasury bonds, U.S., ten-year rate for, 40 Treasury securities, U.S., 434 Trump, Donald, 102 UK See United Kingdom UN See United Nations Unemployed chronically, 556 flows, 555 Unemployment business cycle and, 212, 214f cyclical rate, 561 data, duration of, 556 dynamics of, 554–556, 555f employment and, 39 frictional, 328, 556–557, 557n5 inflation and, 282–283, 282f, 620–621 insurance, 26, 557–558 insurance benefits, 26 macroeconomic variables and, 212, 214f measurement of, 37–39, 39f natural rate of, 284, 284n4, 328, 561–566, 562f, 563n7, 564f, 565t spells, 556 structural, 328, 558–559, 559f wage growth and, 281 See also Non-accelerating inflation rate of unemployment Unemployment rate, cross-country comparisons of (2003–2013), 7, 8f Europe’s, 564–565, 564f, 565t factors, 38–39, 39f, 328, 328n2, 546, 546f government spending and, 4–5, 4f during Great Depression, 7, 7f during Great Recession, 7, 7f of Greece, 7, 8f measurement of, 37–39, 39f, 43, 46 post-WWII, 7, 7f of Switzerland, 7, 8f U.S (1929–2013), 7, 7f for U.S labor market, 546, 547f See also Endogenous variables Unions, 560 United Kingdom (UK), 281 financial crisis (2007–2009) of, 319, 320f per capita income of, 147–148, 147f United Nations (UN) Millennium Project, 188 rankings by, 23 United States (U.S.), 96 currency, 108 economic growth of, 146, 168, 169f education in, 180–181 expenditure components for, 29f GDP, 20, 23, 28f, 31, 207, 427 government budget deficits, 11, 12f inflation rate (1910–2013) of, 7–9, 8f as net debtor, 79–80, 80f, 81f per capita income of, 53–54, 54t, 146–148, 148f real GDP per capita of (1900–2013), 5–6, 5f, 6f saving rate of, 10–11, 10f, 17, 73, 75f, 80 spending, 13 unemployment rate (1929–2013) of, 7, 7f Universities, 182 U.S See United States U.S dollar global financial crisis and, 471 value of, 3, 235–236, 236n3 yardstick, 119 Uses-of-saving identity, 77–78, 77n1, 97 Utility, 498 www.downloadslide.com I-17 Value -added tax, 76 of capital, loss of, 30, 30t imputed, 21 market, 20–22 of output, 20–21 present, 497–499, 498f present discounted, 497–499, 498f of U.S dollar, Variables coincident, 211 consumer optimism, 4–5, 4f endogenous, 4–5, 4f exogenous, 4–5, 4f lagging, 211 leading, 211 in macroeconomic models, 4–5, 4f, 24 nominal, 31 real, 32 See also Economic variables Velocity determinants of, 110 of money, 109–110, 109n3 Vietnam War, 156, 243, 243f Vishny, Robert, 187 Volcker, Paul, 309, 355, 590 Volcker Disinflation, 309–310, 309f, 311f Wage controls, 313 efficiency, 560, 561 employee, 28–30, 30t as flexible, 111, 624 growth and unemployment, 281 non, 65, 66t rate, 60 real, 546, 547f Wage, minimum imposed, 559 laws, 559–560 Wage rate, real application of, 66–68, 67f definition of, 60, 60n8–9 explanation of, 65–66, 65n11, 66t growth of, 66t MPL and, 61, 61n10, 64–65 Walk hypothesis, 515–516, 518 Wall Street, 215, 391 Wall Street Journal, 40, 344 Wars, 17, 156, 243, 243f, 313, 433 See also World War I; World War II Wealth, 97–100, 275 amount of, 49 changes in, 512 consumption to, 501, 501f money and, 102 national, 74 oil, 50 saving and, 73–80, 75f, 79f, 80f, 81f See also Countries, rich Weil, David, 169 Welfare, 498 The White Man’s Burden (Easterly), 188 Women, 551–554, 551f, 552f, 553f, 554f Workers discouraged, 37–38, 555 national income to, 64–68, 66t, 67f, 69, 70 number of, 65n11 saving rate of, 149–150, 150f survey on, 39 Work in process, 535 World Bank, 186–187, 382, 385 WorldCom, 382 World War I (WWI), 210t, 218–233, 218n4, 219f World War II (WWII), 103, 431–432, 454 destruction and economic growth post, 156 inflation rate during, 7–9, 8f unemployment rate post-, 7, 7f U.S business cycle post-, 210t, 218–233, 219f Zaire, 188 Zero lower bound fiscal multiplier at, 443–444, 444f monetary policy and, 355–363, 356f, 358f, 359f, 361f, 364 Zimbabwe, 187 hyperinflation in, 115 inflation rate of, 9, 9f www.downloadslide.com This page intentionally left blank www.downloadslide.com Guide to Commonly Used Symbols Symbol Term γ δ ∆ ε λ π πe πT Π ρ τ χ A AD AS B BR c c c C C C d D D e E Ee Epar ER EX f g gA gK gL gY G GC GI i i I I iD iF IM IS k K kG L fraction of population devoted to R&D parameter that indicates how expectations of future inflation affect current inflation responsiveness of inflation to output gap depreciation rate change in a variable real exchange rate responsiveness of real interest rate to inflation rate inflation rate expected rate of inflation inflation target real economic profits price shock tax rate productivity of research and development available technology (total factor productivity) aggregate demand curve aggregate supply curve bonds borrowed reserves consumption per worker currency ratio responsiveness of consumption to real interest rates consumption expenditure currency in circulation autonomous consumption responsiveness of investment to real interest rates checkable deposits demand curve excess reserves ratio nominal exchange rate expected exchange rate fixed exchange rate excess reserves exports financial friction productivity growth rate growth rate of technology (total factor productivity) growth rate of capital growth rate of labor growth rate of output government purchases government consumption government investment investment per worker nominal interest rate investment autonomous investment interest rate on dollar assets interest rate on foreign assets imports IS curve capital per worker (capital-labor ratio) capital Golden Rule capital-labor ratio labor α β www.downloadslide.com Symbol Term LA LP LRAS LRPC m M Md Ms MB MBn MD MP mpc MPK MPL MRS MS n N NX NX P pk PC r r rc ri R R RD RF rr RR s S S sG SG SP SRAS T U Un uc V w W W x y Y YD YP YP Ype YT labor devoted to producing new technology labor devoted to producing goods and services long-run aggregate supply curve long-run Phillips curve money multiplier money supply demand for money money supply monetary base nonborrowed monetary base money demand curve monetary policy curve marginal propensity to consume marginal product of capital marginal product of labor marginal rate of substitution money supply curve population growth rate (labor force growth rate) population net exports autonomous net exports price or price level real price of unit of capital Phillips curve real interest rate autonomous component of the real interest rate real rental price of capital real interest rate for investments rental price of capital reserves in banking system nominal expected return on dollar assets nominal expected return on foreign assets required reserve ratio required reserves savings per worker supply curve savings or national savings Golden Rule saving rate government savings private savings short-run aggregate supply curve taxes unemployment rate natural rate of unemployment user cost of capital velocity of money real wage rate wage rate initial wealth (assets) responsiveness of net exports to real interest rates income per worker (output per worker) output, income private disposable income potential output permanent income planned expenditure transitory income www.downloadslide.com ® MyEconLab Provides the Power of Practice Optimize your study time with MyEconLab, the online assessment and tutorial system When you take a sample test online, MyEconLab gives you targeted feedback and a personalized Study Plan to identify the topics you need to review Study Plan The Study Plan shows you the sections you should study next, gives easy access to practice problems, and provides you with an automatically generated quiz to prove mastery of the course material Unlimited Practice As you work each exercise, instant feedback helps you understand and apply the concepts Many Study Plan exercises contain algorithmically generated values to ensure that you get as much practice as you need Learning Resources Study Plan problems link to learning resources that further reinforce concepts you need to master ® r Help Me Solve This learning aids help you break down a problem much the same way as an instructor would during office hours Help Me Solve This is available for select problems MyEconLab r eText links are specific to the problem at hand so that related concepts are easy to review just when they are needed Find out more at www.myeconlab.com r A graphing tool enables you to build and manipulate graphs to better understand how concepts, numbers, and graphs connect www.downloadslide.com Real-Time Data Analysis Exercises Up-to-date macro data is a great way to engage in and understand the usefulness of macro variables and their impact on the economy Real-Time Data Analysis exercises communicate directly with the Federal Reserve Bank of St Louis’s FRED® site, so every time FRED posts new data, students see new data End-of-chapter exercises accompanied by the Real-Time 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Unemployment and Inflation, 20 06? ?20 09 Year Unemployment Rate (%) Inflation (Year to Year) (%) 5.4 5.3 5.3 6.4 7.8 7.8 2. 3 2. 3 3.4 3.9 2. 1 2. 1 20 06 20 07 20 08, June 20 08, Dec 20 09, June 20 09, Dec... increased AD… AD2 AD1 Step decreasing output and lowering inflation Y2 YP Aggregate Output, Y (b) Chinese Output Growth and Inflation, 20 06? ?20 09 Year 20 06 20 07 20 08, June 20 08, Dec 20 09, June 20 09, Dec... trillion to AD2, which we represent in equation form as Y = 12. 75 - 0.5π Substituting in for π = + 1.5 Y - 10 from the AS1 curve yields the following: Y = 12. 75 - 0.5 + 1.51Y - 1 024 = 12. 75 - - 0.75Y