MacroEconomics 5e global edition williamson

www.freebookslides.com Macroeconomics The editorial team at Pearson has worked closely with educators around the globe to inform students of the ever-changing world in a broad variety of disciplines Pearson Education offers this product to the international market, which may or may not include alterations from the United States version INTERNATIONAL EDITION INTERNATIONAL EDITION FIFTH EDITION Pearson International Edition Williamson This is a special edition of an established title widely used by colleges and universities throughout the world Pearson published this exclusive edition for the benefit of students outside the United States and Canada If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author INTERNATIONAL EDITION Macroeconomics FIFTH EDITION Stephen D Williamson www.freebookslides.com Macroeconomics Fifth Edition STEPHEN D WILLIAMSON Washington University in St Louis International Edition contributions by Anisha Sharma www.freebookslides.com Editor in Chief: Donna Battista AVP/Executive Editor: David Alexander Acquisitions Editor: Christina Masturzo Senior Editorial Project Manager: Lindsey Sloan Editorial Assistant: Emily Brodeur Director of Marketing: Maggie Moylan Executive Marketing Manager: Lori Deshazo Senior Marketing Assistant: Kimberly Lovato Managing Editor: Jeffrey Holcomb Publisher, International Edition: Angshuman Chakraborty Publishing Administrator and Business Analyst, International Edition: Shokhi Shah Khandelwal Associate Print and Media Editor, International Edition: Anuprova Dey Chowdhuri Acquisitions Editor, International Edition: Sandhya Ghoshal Publishing Administrator, International Edition: Hema Mehta Project Editor, International Edition: Daniel Luiz Senior Manufacturing Controller, Production, International Edition: Trudy Kimber Creative Art Director: Jayne Conte Cover Designer: Jodi Notowitz/Wicked Design Cover Art: Kentoh/Shutterstock Media Project Manager: Lisa Rinaldi Full-Service Project Management: Integra Software Services Pvt Ltd Cover Printer: Lehigh/Phoenix-Hagerstown Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoninternationaleditions.com c Pearson Education Limited 2014 The rights of Stephen D Williamson to be identified as the author of this work have been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 Authorized adaptation from the United States edition, entitled Macroeconomics, 5th edition, ISBN 978-0-132-99133-9, by Stephen D Williamson, published by Pearson Education c 2014 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or 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particular purpose, title and non-infringement In no event shall Microsoft and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from the services The documents and related graphics contained herein could include technical inaccuracies or typographical errors Changes are periodically added to the information herein Microsoft and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time Partial screen shots may be viewed in full within the software version specified Microsoft R and Windows R are registered trademarks of the Microsoft Corporation in the U.S.A and other countries This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation ISBN 10:1-292-00045-7 ISBN 13:978-1-292-00045-9 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 14 13 12 11 10 Typeset in Berkeley-Book by Integra Software Services Pvt Ltd Printed and bound by Courier Westford in The United States of America The publisher’s policy is to use paper manufactured from sustainable forests www.freebookslides.com CONTENTS PA RT I Introduction and Measurement Issues Chapter Introduction 19 20 What Is Macroeconomics? 20 Gross Domestic Product, Economic Growth, and Business Cycles 21 Macroeconomic Models 25 Microeconomic Principles 28 Disagreement in Macroeconomics 29 What Do We Learn from Macroeconomic Analysis? 30 Understanding Recent and Current Macroeconomic Events 33 Chapter Summary 51 Problems 53 Key Terms 51 Working with the Data 54 Questions for Review 52 Chapter Measurement 55 Measuring GDP: The National Income and Product Accounts 55 Nominal and Real GDP and Price Indices 64 MACROECONOMICS IN ACTION: Comparing Real GDP Across Countries and the Penn Effect 72 MACROECONOMICS IN ACTION: House Prices and GDP Measurement 73 Savings, Wealth, and Capital 75 Labor Market Measurement 76 MACROECONOMICS IN ACTION: Alternative Measures of the Unemployment Rate 78 Chapter Summary 80 Problems 82 Key Terms 80 Working with the Data 85 Questions for Review 82 Chapter Business Cycle Measurement 86 Regularities in GDP Fluctuations 86 www.freebookslides.com Contents MACROECONOMICS IN ACTION: Economic Forecasting and the Financial Crisis 89 Comovement 90 The Components of GDP 96 Nominal Variables 99 Labor Market Variables 102 MACROECONOMICS IN ACTION: Jobless Recoveries 104 Seasonal Adjustment 106 MACROECONOMICS IN ACTION: The Great Moderation and the 2008–2009 Recession 107 Comovement Summary 109 Chapter Summary 110 Problems 112 Key Terms 110 Working with the Data 112 Questions for Review 111 PA RT I I A One-Period Model of the Macroeconomy Chapter Consumer and Firm Behavior: The Work–Leisure Decision and Profit Maximization 114 113 The Representative Consumer 115 The Representative Firm 134 MACROECONOMICS IN ACTION: How Elastic is Labor Supply? 135 MACROECONOMICS IN ACTION: Henry Ford and Total Factor Productivity 145 THEORY CONFRONTS THE DATA: Total Factor Productivity and the U.S Aggregate Production Function 146 Chapter Summary 149 Problems 152 Key Terms 150 Working with the Data 154 Questions for Review 151 Chapter A Closed-Economy One-Period Macroeconomic Model 155 Government 156 Competitive Equilibrium 156 Optimality 163 Working with the Model: The Effects of a Change in Government Purchases 169 THEORY CONFRONTS THE DATA: Government Spending in World War II 171 Working with the Model: A Change in Total Factor Productivity 172 www.freebookslides.com Contents THEORY CONFRONTS THE DATA: Total Factor Productivity, Real GDP, and Energy Prices 177 MACROECONOMICS IN ACTION: Government Expenditures and the American Recovery and Reinvestment Act of 2009 180 A Distorting Tax on Wage Income, Tax Rate Changes, and the Laffer Curve 184 A Model of Public Goods: How Large Should the Government Be? 191 Chapter Summary 195 Problems 197 Key Terms 195 Working with the Data 199 Questions for Review 196 Chapter Search and Unemployment 200 Labor Market Facts 201 MACROECONOMICS IN ACTION: Unemployment and Employment in the United States and Europe 205 A Diamond-Mortensen-Pissarides Model of Search and Unemployment 207 Working with the DMP Model 217 MACROECONOMICS IN ACTION: Unemployment Insurance and Incentives 219 THEORY CONFRONTS THE DATA: Productivity, Unemployment, and Real GDP in the United States and Canada: The 2008–2009 Recession 225 A Keynesian DMP Model 227 MACROECONOMICS IN ACTION: The Natural Rate of Unemployment and the 2008–2009 Recession 231 Chapter Summary 232 Problems 234 Key Terms 233 Working with the Data 235 Questions for Review 233 PA RT I I I Chapter Economic Growth 237 Economic Growth: Malthus and Solow 238 Economic Growth Facts 239 The Malthusian Model of Economic Growth 244 The Solow Model: Exogenous Growth 255 THEORY CONFRONTS THE DATA: The Solow Growth Model, Investment Rates, and Population Growth 268 MACROECONOMICS IN ACTION: Resource Misallocation and Total Factor Productivity 270 www.freebookslides.com Contents MACROECONOMICS IN ACTION: Recent Trends in Economic Growth in the United States 271 Growth Accounting 272 MACROECONOMICS IN ACTION: Development Accounting 279 Chapter Summary 281 Problems 283 Key Terms 282 Working with the Data 285 Questions for Review 282 Chapter Income Disparity Among Countries and Endogenous Growth 286 Convergence 287 THEORY CONFRONTS THE DATA: Is Income Per Worker Converging in the World? 292 MACROECONOMICS IN ACTION: Measuring Economic Welfare: Per Capita Income, Income Distribution, Leisure, and Longevity 293 Endogenous Growth: A Model of Human Capital Accumulation 294 MACROECONOMICS IN ACTION: Education and Growth 303 Chapter Summary 305 Problems 306 Key Terms 305 Working with the Data 307 Questions For Review 305 PA RT I V Chapter Savings, Investment, and Government Deficits 309 A Two-Period Model: The Consumption–Savings Decision and Credit Markets 310 A Two-Period Model of the Economy 311 THEORY CONFRONTS THE DATA: Consumption Smoothing and the Stock Market 327 The Ricardian Equivalence Theorem 339 MACROECONOMICS IN ACTION: The Economic Growth and Tax Relief Reconciliation Act and National Saving 349 THEORY CONFRONTS THE DATA: Government Financing Arithmetic: Are Government Budget Deficits Sustainable? 351 Chapter Summary 354 Problems 357 Key Terms 355 Working with the Data 359 Questions for Review 356 Chapter 10 Credit Market Imperfections: Credit Frictions, Financial Crises, and Social Security 360 Credit Market Imperfections and Consumption 362 www.freebookslides.com Contents Credit Market Imperfections, Asymmetric Information, and the Financial Crisis 365 THEORY CONFRONTS THE DATA: Asymmetric Information and Interest Rate Spreads 367 Credit Market Imperfections, Limited Commitment, and the Financial Crisis 369 THEORY CONFRONTS THE DATA: The Housing Market, Collateral, and Consumption 372 THEORY CONFRONTS THE DATA: Low Real Interest Rates and the Financial Crisis 379 Social Security Programs 381 MACROECONOMICS IN ACTION: Transitions from Pay-As-You-Go to Fully Funded Social Security 387 Chapter Summary 388 Problems 390 Key Terms 389 Working with the Data 392 Questions for Review 389 Chapter 11 A Real Intertemporal Model with Investment 393 The Representative Consumer 394 The Representative Firm 400 THEORY CONFRONTS THE DATA: Investment and the Interest Rate Spread 412 Government 414 Competitive Equilibrium 415 The Equilibrium Effects of a Temporary Increase in G: Stimulus, the Multiplier, and Crowding Out 426 MACROECONOMICS IN ACTION: The Total Government Spending Multiplier: Barro vs Romer 430 The Equilibrium Effects of a Decrease in the Current Capital Stock K 432 The Equilibrium Effects of an Increase in Current Total Factor Productivity z 433 The Equilibrium Effects of an Increase in Future Total Factor Productivity, zœ : News About the Future and Aggregate Economic Activity 436 THEORY CONFRONTS THE DATA: News, the Stock Market, and Investment Expenditures 437 Credit Market Frictions and the Financial Crisis 439 THEORY CONFRONTS THE DATA: Interest Rate Spreads and Aggregate Economic Activity 441 Sectoral Shocks and Labor Market Mismatch 443 www.freebookslides.com Contents THEORY CONFRONTS THE DATA: The Behavior of Real GDP, Employment, and Labor Productivity in the 1981–1982 and 2008–2009 Recessions 446 Chapter Summary 449 Problems 451 Key Terms 450 Working with the Data 453 Questions for Review 450 PA RT V Money and Business Cycles 455 Chapter 12 Money, Banking, Prices, and Monetary Policy 456 What Is Money? 457 A Monetary Intertemporal Model 458 A Level Increase in the Money Supply and Monetary Neutrality 472 Shifts in Money Demand 475 THEORY CONFRONTS THE DATA: Instability in the Money Demand Function 478 The Short-Run Non-Neutrality of Money: Friedman–Lucas Money Surprise Model 480 The Zero Lower Bound and Quantitative Easing 490 MACROECONOMICS IN ACTION: Empirical Evidence on Quantitative Easing 493 Chapter Summary 496 Problems 499 Key Terms 497 Working with the Data 500 Questions for Review 498 Chapter 13 Business Cycle Models with Flexible Prices and Wages 501 The Real Business Cycle Model 503 A Keynesian Coordination Failure Model 511 MACROECONOMICS IN ACTION: Business Cycle Models and the Great Depression 512 A New Monetarist Model: Financial Crises and Deficient Liquidity 522 MACROECONOMICS IN ACTION: Uncertainty and Business Cycles 532 Chapter Summary 533 Problems 535 Key Terms 534 Working with the Data 536 Questions for Review 534 Chapter 14 New Keynesian Economics: Sticky Prices 537 The New Keynesian Model 539 The Nonneutrality of Money in the New Keynesian Model 541 www.freebookslides.com Contents THEORY CONFRONTS THE DATA: Can the New Keynesian Model Under Fluctuations in the Interest Rate Target Explain Business Cycles? 543 THEORY CONFRONTS THE DATA: Keynesian Aggregate Demand Shocks as Causes of Business Cycles 544 The Role of Government Policy in the New Keynesian Model 546 Total Factor Productivity Shocks in the New Keynesian Model 549 MACROECONOMICS IN ACTION: The Timing of the Effects of Fiscal and Monetary Policy 550 The Liquidity Trap and Sticky Prices 553 MACROECONOMICS IN ACTION: New Keynesian Models, the Zero Lower Bound, and Quantitative Easing 555 Criticisms of Keynesian Models 557 MACROECONOMICS IN ACTION: How Sticky Are Nominal Prices? 558 Chapter Summary 559 Problems 561 Key Terms 560 Working with the Data 562 Questions for Review 560 PA RT V I Chapter 15 International Macroeconomics 563 International Trade in Goods and Assets 564 A Two-Period Small Open-Economy Model: The Current Account 565 THEORY CONFRONTS THE DATA: Is a Current Account Deficit a Bad Thing? 569 Production, Investment, and the Current Account 573 MACROECONOMICS IN ACTION: The World “Savings Glut” 580 Chapter Summary 581 Problems 583 Key Terms 582 Working with the Data 584 Questions for Review 582 Chapter 16 Money in the Open Economy 585 The Nominal Exchange Rate, the Real Exchange Rate, and Purchasing Power Parity 586 THEORY CONFRONTS THE DATA: The PPP Relationship for the United states and Canada 588 Flexible and Fixed Exchange Rates 588 A Monetary Small Open-Economy Model with a Flexible Exchange Rate 591 www.freebookslides.com 706 Appendix fiat money each, and fiat money is also indivisible Further, a consumer can hold at most one unit of some object at a time, so that at the end of any period a consumer is holding one unit of a good, one unit of money, or nothing It is costless to produce a good and costless to hold one unit of a good or money as inventory At the end of period 0, each consumer not holding money produces a good, and then he or she holds this in inventory until period In period 1, consumers are matched two-by-two and at random, so that a given consumer meets only one other consumer during period Two consumers who meet inspect each other’s goods and announce whether they are willing to trade If both are willing, they trade, and any consumer receiving his or her consumption good in a trade consumes it (this is optimal), receives utility u from consumption, and produces another good Then consumers move on to period and so on No two consumers meet more than once, because there are infinitely many consumers in the population We assume that there are equal numbers of each type of consumer, so that the fraction of the population who are of a given type is 1n Then, in any period, the probability that a consumer meets another consumer of a particular type is 1n What can be an equilibrium in this model? One equilibrium is where money is not valued That is, if no one accepts money, then no one wants to hold it, and because of the absence-of-double-coincidence problem, there is no exchange and everyone’s utility is zero If no one has faith that money has value in exchange, then this expectation is self-fulfilling A more interesting equilibrium is one where everyone accepts money Here, we let m denote the fraction of the population that holds money in equilibrium, Vg denotes the value of holding a good in equilibrium, and Vm is the value of holding money Though there are n different goods, the optimization problems of all consumers are identical in equilibrium, and so the value of holding any good is the same for each consumer The Bellman equations associated with a consumer’s optimization problem are Vg = 1 (1 - m)Vg + m Vg + m (Vm - Vg) , 1+r n n Vm = 1 (1 - m) Vm + (1 - m) (u + Vg ) + mVm 1+r n n (A-99) (A-100) In Equation (A-99), the value of holding a good at the end of the current period is equal to the discounted sum of the expected payoff in the following period In the following period, the consumer meets another agent with a good with probability 1-m, in which case trade does not take place, and the consumer is holding a good at the end of the next period and receives value Vg With probability m(1 - 1n ), the consumer meets another consumer with money who does not wish to purchase the consumer’s good, and again trade does not take place With probability m 1n , the consumer meets a consumer with money who wants his or her good, trade takes place, and the consumer is holding money at the end of the next period In Equation (A-100), a consumer with money does not trade with another consumer who has money or with another consumer who has a good that he or she does not consume However, with probability (1 - m) 1n the consumer meets another consumer with his or her consumption good, in which case trade takes place, the consumer gets utility u from consuming the good, and then he or she produces another good www.freebookslides.com Mathematical Appendix We can solve for Vg and Vm from Equations (A-99) and (A-100), which give Vg = m(1 - m)u , rn(1 + rn) Vm = (rn + m)(1 - m)u , rn(1 + rn) so that (1 - m)u + rn Therefore, the value of holding money is greater than the value of holding a good, so that everyone accepts money (as conjectured) in equilibrium Further, consumers who have money in any period prefer to hold it rather than produce a good, and so we have m = M in equilibrium The values of Vg and Vm are the utilities that consumers receive from holding goods and money, respectively As Vg and Vm 0, everyone is better off in an economy where money is used than in one where it is not used Vm - Vg = Problem Suppose a search economy with the possibility of double coincidences; that is, assume that when an agent produces a good, that she cannot consume it herself In a random match where two agents meet and each has the good that they produced, the first agent has what the second consumes with probability x, the second has what the first consumes with probability x , and each has what the other consumes with probability x2 (a) In this economy, show that there are three equilibria: a barter equilibrium where money is not accepted, an equilibrium where an agent with a good is indifferent between accepting and not accepting money, and an equilibrium where agents with goods always accept money (b) Show that x needs to be sufficiently small before having money in this economy actually increases welfare over having barter, and explain this result The Diamond–Dybvig Banking Model There are three periods, 0, 1, and 2, and an intertemporal technology that allows one unit of the period good to be converted into + r units of the period good The intertemporal technology can be interrupted in period 1, with a yield of one unit in period for each unit of input in period If production is interrupted in period 1, there is no return in period Goods can be stored from period to period with no depreciation There is a continuum of consumers with unit mass, and each consumer maximizes expected utility W = tU(c1 ) + (1 - t)U(c2 ), where ci is the consumer’s consumption if he or she consumes in period i, for i = 1, 2, and t is the probability that the consumer consumes early Here, t is also the fraction of agents who are early consumers We assume that t is known in period 0, but consumers 707 www.freebookslides.com 708 Appendix not know their type (early or late consumer) until period Each consumer is endowed with one unit of goods in period Suppose that there are no banks, but consumers can trade investment projects in period 1, with one project selling for the price p in terms of consumption goods Then, each consumer chooses to invest all of one’s goods in the technology in period 0, and in period a consumer must decide how much of the investment to interrupt and how many investment projects to buy and sell In period an early consumer wants to sell the investment project if p and will want to interrupt the investment project and consume the proceeds if p The early consumer is indifferent if p = A late consumer in period wants to interrupt the investment project and purchase investment projects if p 1, chooses to hold the investment project if p 1, and is indifferent if p = The equilibrium price is, therefore, p = 1, and in equilibrium fraction t of all projects is interrupted in period 1, early consumers each consume c1 = 1, and late consumers consume c2 = + r Expected utility for each consumer in period is W1 = tU(1) + (1 - t)U(1 + r) Now, suppose that there is a bank that takes deposits from consumers in period 0, serves depositors sequentially in period (places in line are drawn at random), and offers a deposit contract (d1 , d2 ), where d1 is the amount that can be withdrawn in period for each unit deposited, and d2 is the amount that can be withdrawn in period for each unit deposited Assume that all consumers deposit in the bank in period Then, the bank chooses d1 , d2 , and x, the quantity of production to interrupt, to solve: max[tU(d1 ) + (1 - t)U(d2 )] (A-101) subject to td1 = x, (A-102) (1 - t)d2 = (1 - x)(1 + r), d1 … d2 (A-103) (A-104) Here, Equation (A-102) is the bank’s resource constraint in period 1, Equation (A-103) is the resource constraint in period 2, and Equation (A-104) is an incentive constraint, which states that it must be in the interest of late consumers to withdraw late rather than posing as early consumers and withdrawing early Ignoring the constraint (A-104), substituting for d1 and d2 using the constraints (A-102) and (A-103) in the objective function (A-101), the first-order condition for an optimum is Uœ x = (1 + r)U œ t (1 - x) (1 + r) 1-t (A-105) with d1 = xt and d2 = (1-x)(1+r) Equation (A-105) then implies that d1 d2 so that 1-t œœ (c) Equation (A-104) is satisfied Further, if we assume that -cU U œ (c) 1, then Equation (A-105) implies that d1 and d2 + r Thus, under this condition, the bank provides consumers with insurance against the need for liquid assets in period 1, and www.freebookslides.com Mathematical Appendix the bank gives consumers higher expected utility than when there was no bank (d1 = and d2 = + r if the bank chooses x = t) However, there also exists a bank-run equilibrium That is, if a late consumer expects all other consumers to run to the bank in period 1, he or she will want to it as well Problems Suppose that consumers can meet and trade in period instead of going to the bank in sequence Show that, given the banking contract (d1 , d2 ), there could be Pareto-improving trades that early and late consumers could make in period that would undo the banking contract, so that this would not constitute an equilibrium Discuss your results Show that, if U(c) = ln c, then there is no need for a bank in the Diamond–Dybvig economy, and explain this result Chapter 18 Inflation, the Phillips Curve, and Central Bank Commitment In this section we construct a somewhat more explicit version of the model we worked with in Chapter 18 to show some of the results of that chapter more formally The first component of the model is the Phillips curve relationship, which captures the key idea in the Friedman–Lucas money surprise model of Chapter 11 That is, i - ie = a(Y - Y T ), (A-106) where i is the inflation rate, is the private sector’s anticipated inflation rate, a 0, Y is aggregate output, and Y T is trend output The second component of the model is the preferences of the central bank, which we represent by supposing that the central bank maximizes f(Y, i), where f(·, ·) is a function That is, the central bank cares about the level of output and the inflation rate It is convenient to express f(Y, i) as a quadratic function, that is, ie f(Y, i) = a(i - i∗ )2 + b(Y - Y ∗ )2 , (A-107) i∗ where a and b are negative constants, is the target inflation rate for the central bank, and Y ∗ is the target level of aggregate output for the central bank Now, suppose, that the central bank treats the anticipated inflation rate ie as being given and chooses i and Y to maximize Equation (A-107) given Equation (A-106) Solving this optimization problem, the central bank then chooses i= aa2 i∗ + bie - ba(Y T - Y ∗ ) aa2 + b (A-108) We then have i - ie = aa2 (i∗ - ie ) - ba(Y T - Y ∗ ) aa2 + b In this circumstance, if the central bank had a target level of output that was higher than trend output—that is, Y T - Y ∗ 0—then even if ie i∗ , in which case anticipated 709 www.freebookslides.com 710 Appendix inflation is higher than the target inflation rate, the central bank may want to have i ie so that the private sector is fooled by positive surprise inflation Ultimately, though, the private sector is not fooled in the long run, so that i = ie If the central bank could commit to an inflation rate, the central bank knows, from Equation (A-106), that it cannot engineer a level of output other than Y T , and the best strategy for the central bank is to set i = i∗ However, suppose the central bank cannot commit to an inflation rate The private sector first chooses ie , then the central bank chooses i, and in equilibrium i = ie In this case Equation (A-108) is the central bank’s reaction function, and we can solve for the equilibrium inflation rate by substituting i = ie in Equation (A-108), getting i = i∗ + b ∗ (Y - Y T ); aa hence, if Y ∗ Y T , in equilibrium the inflation rate is higher than i∗ , which is the inflation rate the central bank would choose if it could tie its hands and commit itself to an inflation policy Problem Suppose that, instead of expectations being rational, expectations are adaptive That is, each period the private sector expects that the inflation rate will be what it was the previous period That is, ie = i-1 , where i-1 is the actual inflation rate last period Under these circumstances, determine what the actual inflation rate and the level of output will be, given i-1 How will the inflation rate and output evolve over time? What will the inflation rate and the level of output be in the long run? Explain your results www.freebookslides.com Index Page numbers with f indicate figures; those with t indicate tables Absence of double coincidence of wants, 630 Absorption, 574 Acyclical variable, 91–92 Adequate financial liquidity, 524 Aggregate demand, 513–14, 514f Aggregate expenditure, components of, 62–64 Aggregate productivity, 33–34 Aggregate supply curve, 541–42, 542f American Recovery and Reinvestment Act (ARRA), 180–84, 427, 430–31 effects of, analyzing, 430–31 government outlays and, 182–84, 182f government spending and, 181–84, 181f Amplitude of business cycle, 87 Appreciation, 595 U.S currency, after financial crisis onset, 598–99, 597f Arbitrage opportunity, 490 Asian Crisis, 580, 598–99 Assets liquidity, 645–46 maturity, 645 prices, 495 properties of, 645–46 rate of return, 645 risk, 645 Asymmetric information, 360, 365–66, 367f interest rate spread and, 367–68 Aten, Bettina, 73 Auerbach, Alan, 350 Average labor demand, 515f Average labor productivity, 33, 34f, 105 with total factor productivity, 487f Balance of payments, 610–11 Bank failures, 658–59 Banking, 625–60, 705–709 Diamond–Dybvig model, 647–54 financial intermediation and, 644–47 panics, 653–54, 658–59 Banking services, cost of, 458t Bank run, 653 Barriers to Riches (Parente and Prescott), 292 Barro, Robert, 430–31, 502 Barter economy, 121 exchange, 630 Bayesian Vector Autoregression (BVAR), 89 Benhabib, Roger, 513 Bernanke, Ben, 107, 580, 643, 657–58 Bernstein, Jared, 431 Beveridge curve on labor market, 204, 210f Biden, Joseph, 431 Bils, Mark, 303–304, 558 Bond, nominal, 460 Boom, 87 Bretton Woods arrangement, 590 Budget constraints, 122–24 consumer’s lifetime, 313–16, 315f government, 156, 337–38 Bureau of Labor Statistics, 76, 200, 558 Bush, George H W., 180 Bush, George W., 191, 349–50, 351 Business cycles, 21–25 See also Real business cycle theory amplitude of, 87 frequency of, 87 Great Depression and, 512 in Keynesian aggregate demand shocks, 544–46, 546t in Keynesian coordination failure model, 511–14 in Keynesian theory, 537–59 measurement, 86–109 new monetarists model, 522–24 peaks, 86 real, 177, 503–11 real GDP and, 21, 22f, 24f, 25f, 26f sticky wage model and, 512 theories of, 29–30 troughs, 86 turning points, 86, 96f in U.S., 44–45, 44f Canada average labor productivity (2008–2012), 226f unemployment rates, 227f real GDP, 228f productivity (2008–2009), 225–26 -U.S Auto Pact, 588 labor market facts (2008–2012), 226f, 227f Capital, 75–76 account, 610–11 inflow, 610 outflow, 610 Capital controls, 610–14 balance of payments, 610–11 effects of, 611–14 in practice, 614–15 Capital stock, 75 equilibrium and, 432–35 Cash-in-advance constraint, 638 model, 700 Cass, David, 692 Central Bank, commitment, 664–78, 709–10 Chain-weighting scheme, in GDP calculation, 66–67, 68f, 71 Chari, V V., 553 Check-clearing system, 477 Classical dichotomy, 473 Classical macroeconomists, 555–56 Clear markets, 157 Closed economy, 155 Closed economy one-period macroeconomic model, 155–95 change in government purchases and, 169–71 711 www.freebookslides.com 712 Index Closed economy one-period macroeconomic model (cont.) change in total factor productivity and, 172–76 competitive equilibrium and, 156–63 distorting tax and, 166 government and, 156 how to use, 167–69 interpreting predictions of, 176–77 optimality and, 163–65 proportional income taxation and, 184–91 social inefficiency sources of, 165–67 Cobb–Douglas production function, 146, 273 Coincident variable, 93 Cole, Harold, 512 Collateral, 361, 369–72, 371f Collateralizable wealth, 361 Commodity-backed paper money, 628 Commodity money, 627, 629–30, 632f Common currency area, 607 Co-movement, 90–96, 106, 109t Comparative advantage, 280 Comparative statistics, 686–87, 696–98 Competitive behavior, 120 Competitive equilibrium, 27–28, 157, 161, 162f, 684–85 closed economy one-period model, 156–63, 162f current capital stock and, 432–33 endogenous growth, 297–99 goods market and output demand curve, 420–24, 422f, 423f government spending and, 426–30 intertemporal model and, 469–71, 470f, 471f intertemporal model with investment and, 415–26 labor market and output supply curve, 415–20, 416f, 418f, 421f, 422f Solow model and, 257–60 total factor productivity and, 433–35, 434f, 435f two-period model, 338–39 Congressional Budget Office, 555–56 Constant returns to scale, 138–40 Constraints budget, 120–24 cash-in-advance, 469 time, 121 Consumer price index (CPI), 67–71 Consumers, 680–84 as borrower, 312, 319f budget constraints, 120–24, 123f, 124f disposable income, 121–22 endogenous growth and, 295–96 indifference curves, 317f in intertemporal model with investment, 394–96 labor market facts, 209, 211–13, 211f, 213f labor supply and, 396–98, 398f, 399f as lenders, 318f lifetime budget constraint, 313–16, 315f lifetime wealth, 314 optimization, 27, 126–44, 318–320, 695–96 preferences, 115–120, 316–18 representative, 115–34, 683 in Solow growth model, 255 two-period model and, 311–36 utility function in Diamond–Dybvig banking model, 649f work, searching, 208–209 Consumption, 62–63, 63t, 372, 373f bundle, 115–16 credit market imperfections and, 342–43, 362–65, 363f, 364f current account, 577–79 demand for goods, 405–409 goods, 115 leisure and, 132–34 lending and borrowing rates and, 364f marginal utility of, 648 of nondurables, 323f optimal bundle, 124–27, 125f, 127f per worker, 263–66, 264f, 265f smoothing, 311, 318t, 323f, 327–28 tax cuts, effects on, 364f trend, 330f Consumption-savings decisions, 310–54 endogenous, 692–95 Convergence, 287–304 in aggregate output, 290f in endogenous growth model, 294–95, 297f world income per worker, 289f, 291f, 292–93 Cooley, Thomas, 503, 642 Cooper, Russell, 513 Coordination failure, 30, 511 Correlation coefficient, 92, 109t negative, 91 positive, 91 Countercyclical variable, 91, 99 Credit market, 46–47, 310–55 equilibrium, 342–43, 342f perfect, 348 Credit market imperfections, 324, 348, 360–89 asymmetric information and, 365–68, 367f consumption and, 362–65, 363f, 364f financial crisis and, 365–66 limited commitment and, 369–72, 371f social security and, 360–88 Crowding out, 38, 170, 426 Currency board, 590 union, 607 Current account consumption and investment, 566–67 deficit, 49–50, 569 government expenditure, effects on, 575, 576f production and investment, 573–79, 582 total factor productivity and, 577–79, 577f, 578f, 579 world real interest rate and, 566–67, 567f Current account surplus, 48–51, 50f, 76 deviations from trend in, 570f key factors affecting, 565–68 Decreasing returns to scale, 138–39 Default premium, 360–61 Deficient financial liquidity, 524 Deficit current account, 49–50, 560 government, 37–39 Deflation, 641 Demand curve labor, 149f, 186f, 421f, 444f, 515f nominal curve, 470f output, 420–33, 423f, 425f, 428f, 432f Demand multiplier, 428 Demography, unemployment rate (2008–2009), 231–32 Deposit insurance, 654 Depreciation, 594, 598–99 Devaluation, 590, 605f exchange rate, 606–607 2008–2012 developments average labor productivity (Canada and U.S.), 226f federal funds rate, 557f inflation, 636f money growth, 636f unemployment rates (Canada and U.S.), 227f real GDP (Canada and U.S.), 228f Diamond, Douglas, 647 Diamond, Peter, 35 Diamond–Dybvig banking model, 647–54, 707–709 bank runs in, 653–54 deposit insurance, 654 equilibrium, 214–17, 216f Keynesian model, 227–31 unemployment, 207–208, 217 utility function for consumer in, 649f working with, 217 Discouraged workers, 79 Disposable income, consumer, 121–22 Distorting taxes, 166 Laffer curve and, 184–91, 189f www.freebookslides.com Index on tax rate changes, 187–91 on wage income, 184–87 Dividend income, 121 Dollarize, 590 Double coincidence of wants, 459 absence of, 630 Dybvig, Philip, 647 Dynamic decision, 114 Economic growth, 238–72, 690–92 education and, 303–304 endogenous models, 239 exogenous model, 239–82 facts, 239–44 growth accounting, 272–79 Malthusian model, 244–55 policy and, 299–303 Solow model, 255–72 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), 349–50 Economic models, 20 Education, economic growth and, 303–304 Edwards, Sebastian, 614 Efficiency units of labor, 296 Efficiency wage theory of unemployment, 35f Emergency Economic Stabilization Act of 2008 (EESA), 551, 655 Employed, 76–77 Employment/population ratio, 77 Endogenous consumption-savings decisions, 692–95 Endogenous growth, 286–305 competitive equilibrium, 297–99 consumers and, 295–97 convergence in, 287–94, 301–304 economic policy and, 299–301 equilibrium real wage in, 297f firms and, 296–97 models, 29, 239 Solow growth model and, 294–95 Endogenous money, 508–509, 508f Endogenous variable, 156, 157f Endowment point, 315 Equilibrium, 27–28 See also Competitive equilibrium capital stock and, 432–33, 432f competitive, 27, 157, 162f, 684–85 credit market, 342–43, 342f deposit contract, 652f DMP model, unemployment, 214–17 government spending and, 426–30 in labor market, 416f, 436 multiple, 513–14 total factor productivity and, 433–35, 432f, 433f Essay on the Principle of Population, An (Malthus), 244 Euro, 590 Europe, unemployment in, 205–206 European Central Bank (ECB), 590 European Monetary System (EMS), 590 European Monetary Union (EMU), 388, 590, 608–609 European Union (EU), 564 Excess variability, 323 Exchange rate devaluation, 604–606 fixed, 588–91 flexible, 588–91 nominal, 586–87 real, 586–87, 589f Exogenous growth model, 239, 255–72 See also Solow growth model Exogenous variable, 156, 157f Expenditure approach, to GDP measurement, 55, 58 Externalities, 165 human capital, 303 Federal Deposit Insurance Corporation (FDIC), 654 Federal funds rate, 488 Federal Open Market Committee (FOMC), 488, 550, 674 Federal Reserve Bank of Minneapolis, 89, 512 Federal Reserve Board, 580 Federal Reserve Bulletin, 458 Federal Reserve System (Fed), 32, 39, 107, 458, 463, 469, 606, 627, 628, 643, 653, 657 balance sheet, 453–64 federal funds rate, 555–56 inflation and, 39 Fedwire, 628 Fiat money, 628, 630–33, 633f Financial crisis asymmetric information and, 365–68 credit market imperfections and, 369–80 limited commitment and, 369–72 perspectives on, 372–73 total government spending multiplier, 430–31 Financial intermediary, 365, 626 Financial intermediation, 644–47 Firms, 114–50 endogenous growth and, 296–97 in intertemporal model with investment, 400–10 investment decision, 405–11 labor demand, 402–405 optimization by, 27 profit maximization and, 144–49, 148f, 149f, 402–405 representative, 134–49, 685–86 vacancy rate, 209 First fundamental theorem of welfare economics, 165 Fiscal policy, 156, 521–22, 521f timing of effects, 523–24 713 Fisher, Irving, 460 Fisher effect/relation, 460–61, 639 Fixed exchange rate, 588 capital controls under, 612f devaluation of currency and, 604–606 versus flexible, 606–607 nominal foreign shock under, 601–602, 602f real foreign shock under, 602–604 regime, 588 small open-economy with, 599–601 world interest rate increase and, 603f Fixed investment, 63 Flexible exchange rate, 588–95 versus fixed, 606–607 neutrality of money with, 593–95 nominal foreign shock under, 595–98, 596f real foreign shock under, 595–98 regime, 588 small open-economy model, 591–93, 593f world interest rate increase and, 597f Flows, 75 Ford, Henry, 143, 145 Foreign direct investment, 610 Free Banking Era, 627–28 Frequency of business cycle, 87 Friedman, Milton, 101, 325, 456, 473, 480, 484, 509, 523, 537, 550, 634 Friedman–Lucas money surprise model, 541, 664–69 Phillips curve relationship in, 669f Friedman rule, 626, 641–44 Fully funded social security, 381, 384–87, 385f transition from pay-as-you-go, 381–84 Gali, Jordi, 553 General Agreement on Tariffs and Trade (GATT), 564 General Theory of Employment, Interest, and Money, A (Keynes), 29, 501 Gertler, Mark, 537 Golden rule quantity of capital per worker, 263–66, 265f savings rate, 264 Gold standard, 628 Goods market in monetary small open-economy model, 592f output demand curve and, 420–24, 425f, 428f, 432f, 436 Government, 156 budget constraint, 156 burden of debt, 347–49 deficit, 37f, 39, 76 equilibrium effects, 426–30 expenditures, 64, 172f, 180–84, 181f, 413f www.freebookslides.com 714 Index Government (cont.) growth model and, 349–51 in intertemporal model, 467–69 in intertemporal model with investment, 414 intervention, 547–48 policy, real business cycle theory and, 510–11 present-value budget constraint, 337–38 purchases, effects of change in, 169–71, 172f saving, 38f, 38–39, 76 segmented markets model, policy, 488–89 spending, 37–39, 170f, 172f, 419f, 548–49, 548f sticky price model policy, 546–49 surplus, 38, 38f, 39, 76, 351 two-period model and, 311–12 Great Depression, 512 bank failures and banking panics in, 658–59 business cycle models and, 512 deflation during, 642 gross domestic product in, 21–25, 22f, 24f, 25f Great Moderation, 107 Greenspan, Alan, 517, 673–74 Gross domestic product (GDP), 21, 55, 63t, 446f co-movement, 90–96, 96, 109t components of, 96–99, 97f, 98f defined, 21 exclusions with, 61–62 exports/imports as percentage of, 49f fluctuations in, 86–89, 87f, 88f measuring, 55–64 nominal, 64–67, 68f real, 64–67, 65t, 71–75 real, per capita, 22f, 24f, 25f residential construction as, 73–75, 74f total taxes/government spending and, 37–39, 37f Grossman, Sanford, 488 Gross national product (GNP), 61 Growth accounting, 272–75 Growth component, 23 Guo, Jang-Ting, 513 Hansen, Gary, 503, 642 Hard pegs, 589–90 Helicopter drop, 473 Heston, Alan, 73 Hsieh, Chang-Tai, 279 Human capital accumulation, 294–95, 298f defined, 295 externalities, 303 recessions and, 279–80 Hyperinflations, 642 Implicit GDP price deflator, 67–71 Income approach to GDP measurement, 55, 61–62, 64 changes in, 325–29, 326f convergence worldwide, 289f, 290f, 292–93 dividend, 121 effect, 129–34, 133f increase in future, 324–25, 325f private disposable, 75 real per-capita, 243f, 244f Income–expenditure identity, 59 Increasing returns to scale, 138–39 Indifference curve, 117–18, 118f, 119f, 318f, 572f map, 117 Inferior goods, 117 Inflation, 32, 39–41, 626–60, 705–707, 709–10 central bank commitment and, 664–77 Friedman rule and, 640–44 in Hong Kong, 590 long-run in monetary intertemporal model, 634–40 money growth rate and, 40f in New Zealand, 643 Phillips curve and, 665–77 rate, 40f, 42f, 64, 69f, 456, 460, 635f, 643–44, 664f, 666f rate reduction, 643–44 targeting, 485, 489, 643–44 tax, 473 Interest rate, 41–44 nominal, 41–43, 40f, 459–62, 461f, 491f, 526f nominal rate targeting, 485–88 real, 41–44, 43f, 314–15, 320, 328–35, 331f, 332f, 334f, 335t, 456, 460, 461f, 483f, 516f spreads, 47f, 361, 412–14, 441–42 world real, 574–75, 575f Intermediate good, 56 International macroeconomics, 564 International Monetary Fund (IMF), 590–91 International trade, 60–61 in goods and assets, 564–81 real exchange rate, 586 Intertemporal decisions, 310 Intertemporal model complete, 69–70, 471f monetary, 456–96, 474f, 700–705 Intertemporal model with investment, 393–450, 698–700 competitive equilibrium and, 415–30 consumers and, 394–96 demand for consumption goods, 401f financial crisis and, 410, 439–41 firms and, 400–402 government and, 414 interest rate spread and, 412–14, 413f, 414f labor supply and, 396–98, 398f, 399f Intertemporal substitution effect, 334–35 of labor, 177 of leisure, 397 Inventory investment, 60, 63 Investment, 63, 434f current account and, 573–75 firms decision, 405–13 fixed, 63 foreign direct, 592 inventory, 60, 63 marginal benefit from, 406 marginal cost of, 405–406 as percentage of GDP, 581f rates, Solow growth model and, 268 IS curve, 540, 540f Jevons, William Stanley, 459 Job openings and labor turnover survey ( JOLTS), 203 John, Andrew, 513 Kehoe, Patrick, 553 Keynes, John Maynard, 30, 511 Keynesian aggregate demand shocks, 544–46, 545f Keynesian business cycle theory, 501–33 labor market in sticky wage model, 541–42, 542f Keynesian coordination failure model, 29, 30, 511–22 average labor productivity in, 519f critique of, 522 example of, 517 labor market in, 515f multiple equilibria in, 518f output supply curve in, 521f policy implications of, 521–22 predictions of, 517, 519t procyclical money supply in, 520f stabilizing fiscal policy in, 521f Keynesian DMP model, 227–31 Keynesian ideas, 227 Keynesian macroeconomics, 180 Keynesian transmission mechanism for monetary policy, 542 Kiyotaki, Nobuhiro, 631 Kiyotaki–Wright monetary search model, 705–707 Klenow, Peter, 271, 279–80 Koopmans, Tjalling, 692 Kotlikoff, Laurence, 350 Kydland, Finn, 30, 503 Labor demand, 402–405, 403f, 404f, 515f efficiency units of, 296–97 hoarding, 510 www.freebookslides.com Index intertemporal substitution of, 177 market, 515f Labor demand curve, 149f, 186f, 421f, 444f, 515f Labor force attachment, measuring, 78 growth, 266–67, 267f participation rate, 208f Labor hoarding, 510 Labor market Beveridge curve and, 204, 210f in Canada, (2008–2012), 226f, 227f consumers, 209, 211–13, 211f, 213f demand side, 213–14, 214f DMP search model, 207–208, 217 employment rate, 205–206 employment/population ratio, 201–203, 204, 208f equilibrium, 214–17, 216f in Europe, 205–206 firms and, 209, 213–14, 213f Job Openings and Labor Turnover Survey (JOLTS) on, 203 Keynesian DMP model, 227–31 matching efficiency, 209–11, 221–22, 222f, 223, 224f measurement, 76–78 men/women, participation rate, 206f Nash bargaining theory, 214–15, 688 output supply curve and, 415–20, 416f participation rate, 201–203 productivity increase in, 221–22, 222f in sticky price model, 539–40, 540f supply side, 211–13, 213f tightness, 77, 212 2008–2009 recession, 209, 210f, 225–26, 231–32 in U.S., 202f, 205–206, 225–26, 227f variables, 102–103 Labor market mismatch sectoral shocks in, 443–45 Labor productivity, 105, 106f, 226f Labor supply curve, 131, 132f, 133f, 398f, 399f intertemporal model with investment and, 397–98 taxes and, 135–36 Laffer, Arthur, 184 Laffer curve, 184 income tax revenue and, 187–89, 189f U.S economy and, 190–91, 190f Lagging variable, 93, 95f Law of one price, 587 Leading variable, 93, 95f Learning by doing, 289 Leisure, 115, 119f consumption and, 132–34 intertemporal substitution of, 397 Lender of last resort, 591 Lifetime budget constraint, 313–15, 315f Lifetime wealth, 314, 403f Limited commitment, 360, 369–79 Liquidity, 522 effect, 524–29 trap, 529–31 LM curve, 538 Long-run growth, 20–21 Long-run implications, 173, 177 Lucas, Robert E., Jr., 27, 29, 89, 238, 294, 303, 431, 456, 480, 538 Lucas critique, 29 Lump-sum tax, 121 Macroeconomics analysis, 30–33 current events in, 33–51 defined, 20–21 disagreements in, 29–30 forecasting in, pitfalls of, 89–90 Keynesian, 29 models, 25–28 Malthus, Thomas, 238–39, 244–45 Malthusian model, 238, 244–79 steady state, analysis of, 248–53 usefulness of, 253–55 Marginal benefit from investment, 406 Marginal cost of investment, 405–406 Marginally attached, 78 Marginal product, 137, 138f, 139f of labor schedule, 140–41, 141f Marginal propensity to consume, 399 Marginal rate of substitution, 119–20 of transformation, 161 Marginal utility of consumption, 648 Market clearing, 157 Market segmentation theory, 585 Martingale, 327 Matching efficiency, 209–11, 223, 224f Matching function, 210 Maturity asset, 494, 645 McGratten, Ellen, 553 Measurement, 55–80 business cycle, 86–109 gross domestic product, 55–67 labor market, 76–80 nominal gross domestic product, 64–67 price indices, 64–67 price level, 67–73 real gross domestic product, 64–67, 71–73 savings, wealth, and capital, 75–76 Medium of exchange, 457 Menu cost models, 537, 539 Microeconomics, principles, 29 Models, defined, 26 Monetarist, 484 Monetary aggregates, 458, 458t Monetary base, 458 Fed’s balance sheet and, 463 price level and, 507t 715 Monetary History of the United States A, 1867–1960 (Schwartz), 550 Monetary intertemporal model, 458–64, 468f, 700–705 banks and, 462–64, 477f competitive equilibrium and, 415, 470f, 471f equilibrium in credit card balance market and, 464–67, 464f, 465f, 466f Fisher relation, 459–60 government and, 467–69 long-run inflation in, 634–44 money market in, 470f nominal money demand curve in, 468f real and nominal interest rates, 459–62 transactions and, 457–58, 458t Monetary neutrality, 472–75, 474f Monetary policy, 676–77 alternative rules, 489–90 asset prices and, 495 Keynesian transmission mechanism for, 542 liquidity trap, 491f optimal, 640–42 quantitative easing, 490–96 stabilization policy in, 547f targets and rules for, 484–88 timing of effects, 550–51 Volcker recession and, 673–74 yield curve, 492f zero lower bound interest rate, 490–93 Monetary policy rules, 489–90 Money, 626–60, 705–707 alternative forms of, 627–29 bank’s role, in dealing, 462–64 circulating private bank notes, 627–28 commodity, 630–32, 631f commodity backed paper, 628 competitive equilibrium, 469–70 credit card services, 464–67, 464f, 465f, 466f, 476f defined, 457 demand, shifts in, 464–67, 464f, 466f, 467f, 475–78, 476f, 477f, 479f endogenous, 508–509, 508f fiat, 630–33, 633f Fisher relation, 459–62 government’s role, in issuing, 467–69 intertemporal model, 458–59, 468f, 469–70, 471f growth rate, 484, 635f measuring supply, 457–58, 458t neutrality of, 456, 472–75 nominal interest rate, 459–62, 461f, 466f non-neutrality of, 480–84, 483f in open economy, 565–81 outside, 458 payment means, alternatives, 489–90 policy, 484–93, 486f, 487f www.freebookslides.com 716 Index Money (cont.) procyclical supply, 508f real interest rate, 459–62, 461f, 468f segmented markets model, 488–89 short-run non-neutrality, 480–84 superneutral, 640 supply, 457–58, 462–64, 470–75, 472f, 474f, 481–82, 483f supply targeting, 488 Taylor rule, 490 Money demand function, 478–80 Money market, 470f in monetary small open-economy model, 592f, 596f Money surprise model, 484 Moral hazard, 386–87, 654 Mortensen, Dale, 35, 200, 207 Multiple equilibria, 513, 518f Multiplier process, 426–30 Nash bargaining theory, 214 National Banking Era, 653–54 National Income and Product Accounts (NIPA), 55–57, 144 government expenditures and, 64 real GDP and, 64–66 National Industrial Recovery Act of 1933, 512 National present-value budget constraint, 566 National saving, 76, 349–50 Natural rate of interest, 541 Natural rate of unemployment, 231–32 Negative correlation, 91 Net exports, 49, 64 Net factor payments, 49 Net marginal product of capital, 406 Neutral, 472 Neutrality, monetary, 456, 459, 472–75, 472f, 593–95 New Keynesian economics, 30 Nominal bond, 460 Nominal change, 64 Nominal exchange rate, 586–87 Nominal foreign shock, 601–604, 603f Nominal gross domestic product (GDP), 64–68, 68f targeting, 490 Nominal interest rate, 41–42, 42f, 460, 461f, 466f, 479f targeting, 489–90 Nominal money demand curve, 468f Nominal prices, 558 Nominal shock, 595–98 Nominal variables, 99–103 Nondiversifiable risk, 645 Non-Keynesian, 29 Nonrivalry, 295 Normal goods, 117 North American Free Trade Agreement (NAFTA), 564, 588 Not in the labor force, defined, 77, 80 Numeraire, 121 Obama, Barack, 180 Ohanian, Lee, 512 Open economy, 155 money in, 585–620 Open market operation, 473 purchase, 473 sale, 473 Optimal consumption bundle, 125–27, 127f, 134f Optimal growth, 692–95 Optimal investment numerical example, 409–10 rule, 406 schedule, 407, 407f Optimality, 163–65 Pareto, 163, 168f, 640 social inefficiencies, sources of, 165–67 Optimal monetary policy, 640–42 Optimize, 27 Organization of Petroleum Exporting Countries (OPEC), 45, 178 Output demand curve, 420–24, 423f, 425f, 428f, 432f Output gap, 541 Output supply curve in coordination failure model, 516f defined, 417 labor market and, 415–20, 416f, 418f shift in, 483f Outside money, 458 Parente, Stephen, 292 Pareto optimality, 163, 168f, 640 Partial expenditure multiplier, 429 Participation rate, 77, 201–203 Pay-as-you-go social security, 381–84 for consumers, 382f, 383f transition from, to fully funded, 387–88 Payments, balance of, 610–11 Peaks, 86 Penn effect, 72–73 Penn World Tables, 73 Perfect complements, 132–34, 134f, 335–36, 336f Perfect credit markets, 348, 362 Perfectly negatively correlated, 92 Perfectly positively correlated, 92 Perfect substitutes, 134 Permanent income hypothesis, 325 Persistent, deviations from trend, 87–89, 88f Per-worker production function, 248, 249f, 250f Phillips, A W., 99, 665 Phillips curve, 32–33, 99–100, 664–77, 666f, 667f, 669f, 671f, 673f, 675f, 709–10 reverse, 99–100, 100f shifting, 667f Pissarides, Christopher, 35, 200, 207, 688 Pollution rights, markets in, 166 Population control, 253, 254f growth, 244–48, 246f Solow growth model and, 255 Portfolio inflows, 610 outflows, 610 Positive correlation, 91 Prescott, Edward, 30, 136, 292, 503 Present value, 314 Price asset, 495 energy, 179f index, 64 law of one, 587 nominal, 558 Price level, 64–73, 100f, 101f aggregate output and, 71 energy prices and, 177–79 measuring, 67–73 monetary base and, 635f Private disposable income, 75 Private sector saving, 75 Procyclical variable, 91–92, 93f, 94f Product approach to GDP measurement, 55, 57–58 Production current account and, 573–75, 580 in small open economy, 567f, 573–74 Production function, 137, 138f, 139f, 514f Cobb-Douglas, 146, 147 per-worker, 248, 249f, 257f total factor productivity, effect on, 142–44, 141f, 142f U.S aggregate, 144 Production possibilities frontier (PPF), 160f, 161 Productivity aggregate, 33–34 average labor, 33–34, 34f, 105 recovery, 275–77 slowdown, 33–35, 275–77 total factor, 137 Profit maximization, representative firm and, 144–49, 147f, 148f Progressive tax system, 135–36 Properties of assets, 645–46 Proportional income taxation, 184–87 Public goods, 156 Purchasing power parity (PPP), 586–88, 589f for U.S and Canada, 588, 589f Pure income effect, 128 www.freebookslides.com Index Quantitative easing (QE), 491 Rate of return, 645 Rational consumer, 126, 361 Rational expectations hypothesis, 672, 673 revolution, 29 Razin, Assaf, 387 Reagan, Ronald, 180, 190 Real business cycle theory, 29–30, 178, 503–10 critique of, 510–11 for government policy, 509–10 money supply and, 507–509 total factor productivity, effects of, 505f, 506f, 507t total factor productivity in, 508f Real change, 64 Real exchange rate, 586–87, 588, 589f Canada vs U.S., 589f Real foreign shock, 602–604 Real gross domestic product, 64–67, 71–73 energy prices and, 177–79, 179f labor force participation rate, 207f measuring, problems with, 67–71, 70f productivity in (1981–1982) recession, 446–48 productivity in Canada (2008–2009 recession), 225–26 productivity in Canada (2008–2012), 228f productivity in U.S (2008–2009 recession), 225–26 productivity in U.S (2008–2012), 228f unemployment rate and trend, 203f Real income vs investment rate, 242f vs population growth rate, 243f Real interest rate, 41–42, 42f, 310–11, 313–15, 320f, 331f, 332f, 335t, 460–62, 468f, 471f, 483f world, 574–75 Real per-capita income, 24f, 242f, 243f, 244f Real shocks, 503, 598, 606 Real wage, 103, 121 changes in, 129–31, 132f 2008–2009 recession American Recovery and Reinvestment Act (ARRA), 180–84 business cycle in U.S., 44 consumption expenditure, 372f employment in U.S, 447f exports and imports, 49f financial crises, 46, 47f, 361, 439, 550–51 fuel price, 179f government surplus, 38f, 39, 351 inflation rate, 39–40 interest rate spread, 368f, 413, 441–42 jobless recovery, 105f labor productivity, 446–48 natural rate of unemployment, 231–32 productivity in Canada, 225–26 productivity in U.S., 225–26 real GDP trend, percentage deviation, 44f, 45, 88f, 225–26 retail interest rate, 43f The Great Moderation, 107 treasury inflation-protected securities (TIPS) yields, 380f unemployment rate, 201, 202f, 225–26 Recession, 87 See also specific entries causes of, 44–45 Volcker, 45, 673–74 Relative price, 126, 177–78, 178f of energy, 177–78, 178f of housing, 48f, 73–75, 74f Replacement ratio, 220 Representative consumers, 115–34, 680–82 Representative firms, 134–49, 683 Repurchase agreement, 369 Reserve Bank of New Zealand (RBNZ), 489 Rest point, 247 Revaluations, 590 Reverse Phillips curve, 99–100, 100f Ricardian equivalence theorem, 39, 310, 339–49 in consumption–savings decisions, 310–11 credit market equilibrium and, 342–43, 342f government debt, burden of, 337–38 graph, 341, 341f numerical example of, 339–40 social security and credit market imperfections, 361–62 Ricardo, David, 311 Risk, 645 nondiversifiable, 645 Risk-averse, 645 Romer, Christina, 431 Romer, Paul, 295 Rotemberg, Julio, 488 Sadka, Efraim, 387 Samuelson, Paul, 94, 537 Sargent, Thomas, 502, 642 Savings, 75–76 glut, 580 government, 76 national, 76, 349–50 private sector, 75 rate, 263–65, 263f, 265f Scale constant returns to, 138–40 decreasing returns to, 138 increasing returns to, 138 Scatter plot, 91, 92f 717 Schwartz, Anna, 101, 509, 523, 634 Search model of unemployment, 687–90 Search theory of unemployment, 231–32 Seasonal adjustment, 106–108, 108f Second fundamental theorem of welfare economics, 165 Sectoral shift, 205–206 Sectoral shock, 443 average labor productivity, 445f defined, 443 effects, 444f labor market mismatch, 443–45 Segmented markets model, 488–89 Seigniorage, 473, 590 Separation rate, 689 Shocks aggregate demand, 544–46, 545f monetary, 503–507 nominal, 595 real, 595–98 real foreign, 602–604 terms of trade and, 591 Short-run implications, 173 Sims, Christopher, 89 Single coincidence of wants, 459 Small open economy (SOE), 565 credit market imperfections, 568–72, 573f current account surplus, 581f effects of World real interest rate increase on, 574–75 with fixed exchange rate, 588–91 with flexible exchange rate, 599–601, 601f foreign price level in, 602f goods market, 592f government spending and, 575–76 indifference curves of, 567f investment, 573–74, 574f production and consumption in, 570f production and investment in, 573–74, 574f total factor productivity and, 577–79, 578f two-period model of, 565–68 Smith, Adam, 30, 458–59 Social inefficiencies, sources of, 165–67 Social Security, 381–87 fully funded, 381, 384–88, 385f Pareto improvement and, 384 pay-as-you-go, 381–84, 382f, 383f programs, 381 Ricardian equivalence and, 378–79 Soft pegs, 589, 590 Solow, Robert, 146, 239 Solow growth model, 239, 255–72, 692–95 competitive equilibrium and, 257–60 consumers and, 255–56 investment rates and population growth, 268 representative firm and, 256–57 www.freebookslides.com 718 Index Solow growth model (cont.) resource misallocation, 270–71 steady state analysis of, 260–69, 261f Solow residuals, 146, 147f, 177–79, 274–78, 503, 504f, 510–11 gross domestic product and, 504f Stabilization, 546 using fiscal policy, 548f using monetary policy, 547f Stabilization policy, 546–47 Standard deviation, 96, 97–98, 109t Static decision, 114 Statistical causality, 509 Steady state, of population, 247f analysis of, 248–53, 260–68 consumption per worker, 259f, 261f, 264f determination of, 247f, 250f Sticky price model, 539–41, 540f aggregate supply curve, 541–42, 542f business cycles and, 543–46 criticisms of, 557–59 demand for investment goods in, 545f government policy in, 546–49 labor market in, 539–41, 540f liquidity trap in, 554f total factor productivity shocks in, 549–53, 552f Sticky wage model, 512 Stock market, consumption smoothing and, 327–28, 329f Stocks, 75 price index, 438f prices, 330f Store of value, 457 Strategic complementarities, 513 Substitution effect, 129–31, 130f Summers, Robert, 73 Sunspots, 517 Superneutral, 640 Supply curve, output See Output supply curve Supply-side economists, 190 Surplus current account, 48–50 government, 38–39, 38f, 76 Survey of Current Business, 55 Tax base, 188 Taxes See also Distorting taxes cut, 364f GDP and government spending, 37–39, 37f, 38f inflation, 473 labor supply and, 135–36 lump-sum, 121 proportional income taxation, 184–87 Taylor rule, 490 Time consistency problem, 671–72, 780 constraint, 121 series, 90–91, 91f Too-big-to-fail doctrine, 654–60 Total factor productivity, 137, 143f, 291f average labor productivity with, 506f change in, 174f, 175–79, 178f effect on production function, 142, 157f energy prices and, 177–79, 179f equilibrium and, 433–35, 434f, 435f growth, 272–75 Henry Ford and, 145 income and substitution effects of, 175f increase in, 267–69, 421, 577–79, 578f, 579f, 582 in real business cycle theory, 503 steady state effects of, 267–68 U.S aggregate production function and, 146 Total factor productivity shock capital controls and, 612f, 613f devaluation and, 605f Total government expenditure multiplier, 429 Trade, international, 564–81 Transfers, 64 Trend component, 23 per capita real GDP and, 25f, 26f Troubled Asset Relief Program (TARP), 551 Troughs, 86 Turning points, 86, 96f Two-good model, consumption, 122 Two-period model, 695–98 competitive equilibrium, 338–39 consumers and, 312–38 defined, 310–11 government and, 337–38 Two-period small open economy model, 565–68 UI Benefit, 217–19, 218f insurance and incentives, 219–20 Underground economy, 62 Unemployed, 77 Unemployment rate, 35f, 77 in Europe, 205–206 in U.S., 201–203, 202f, 205–206, 225–26, 227f Unemployment Beveridge Curve on, 210f Diamond–Mortensen–Pissarides (DMP) model of search, 207–208 in Europe, 205–206 incentives, 219–20 insurance, 219–20 real GDP deviations, 203f 2008–2009 recession and, 225–26, 231–32 in U.S., 201–203, 202f, 205–206, 225–26, 227f vacancy rate, 209f United States average labor productivity (2008–2012), 226f bank failures and banking panics in, 658–59 business cycles in, 44–45, 44f housing market in, 372, 373f labor productivity (1981–1982, 2008–2009) recessions, 446–48 Laffer curve and economy, 188–91, 189f money, 457–58 productivity (2008–2009), 225–26 real GDP, 228f unemployment rate, 202f, 205–206, 225–26, 227f Unit of account, money as, 457 Utility function, 115 Value-added approach to GDP measurement, 57–58 Variables coincident, 93 endogenous, 156, 157f exogenous, 156, 157f labor market, 102–106 lagging, 93, 95f leading, 93, 95f nominal, 99–102 Volcker, Paul, 45, 673 Volcker recession, 673–74 Wage flexible, 502 nominal, 418–19, 484–85 real, 482, 483f, 485 Wallace, Neil, 502 Wants absence of double coincidence of, 630–33 double coincidence of, 459 single coincidence of, 459 Wealth, 75–76 Wealth of Nations (Smith), 30, 145 Weiss, Laurence, 220, 488 Welfare economics first fundamental theorem, 165 measurement, 293–94 second fundamental theorem, 165, 168f Welfare-improving role, active monetary policy, 386 World Trade Organization (WTO), 564 World War II business cycle models, 512 government spending in, 171, 172f gross domestic product in, 21–24, 22f, 24f, 26f Wright, Randall, 523 Yield curve, 492 Yap stones, 629–30 Zero lower bound interest rate, 490–93 www.freebookslides.com www.freebookslides.com ... New in the Fifth Edition The first four editions of Macroeconomics had an excellent reception in the market In the fifth edition, I build on the strengths of the first four editions, while producing... Act 1988 Authorized adaptation from the United States edition, entitled Macroeconomics, 5th edition, ISBN 978-0-132-99133-9, by Stephen D Williamson, published by Pearson Education c 2014 All...www.freebookslides.com Macroeconomics Fifth Edition STEPHEN D WILLIAMSON Washington University in St Louis International Edition contributions by Anisha Sharma www.freebookslides.com