THE CORE
Introduction 1
Chapter 1 A Tour of the World 3
1-1 The Crisis 4
1-2 The United States 6
Should You Worry about the United
States Deficit? 8
1-3 The Euro Area 9
How Can European Unemployment
Be Reduced? 10 • What Has the Euro
Done for Its Members? 12
1-4 China 13
1-5 Looking Ahead 15
Appendix: Where to Find the Numbers 17 Chapter 2 A Tour of the Book 19
2-1 Aggregate Output 20 GDP: Production and Income 20 • Nominal and Real GDP 22 • GDP:
Level versus Growth Rate 24
2-2 The Unemployment Rate 25
Why Do Economists Care about
Unemployment? 27
2-3 The Inflation Rate 28
The GDP Deflator 29 • The Consumer
Price Index 29 • Why Do Economists
Care about Inflation? 30
2-4 Output, Unemployment, and the
Inflation Rate: Okun’s Law and the
Phillips Curve 31
Okun’s Law 31 • The Phillips Curve 32
2-5 The Short Run, the Medium Run, the Long Run 33
2-6 A Tour of the Book 34
The Core 35 • Extensions 35 • Back to
Policy 36 • Epilogue 36
Appendix: The Construction of Real GDP, and Chain-Type Indexes 39
Preface xiii
The Short Run 41
Chapter 3 The Goods Market 43
3-1 The Composition of GDP 44
3-2 The Demand for Goods 45
Consumption (C) 46 • Investment
( I ) 48 • Government Spending (G) 48
3-3 The Determination of Equilibrium
Output 49
Using Algebra 50 • Using a Graph 51 •
Using Words 53 • How Long Does It
Take for Output to Adjust? 54
3-4 Investment Equals Saving: An Alternative Way of Thinking about Goods—Market Equilibrium 56
3-5 Is the Government Omnipotent? A Warning 59
Chapter 4 Financial Markets 63
4-1 The Demand for Money 64
Deriving the Demand for Money 66
4-2 Determining the Interest Rate: I 67 Money Demand, Money Supply, and the Equilibrium Interest
Rate 68 • Monetary Policy and Open
Market Operations 70 • Choosing
Money or Choosing the Interest
Rate? 72 • Money, Bonds, and Other
Assets 72
4-3 Determining the Interest Rate: II 73 What Banks Do 73 • The Supply
and the Demand for Central Bank Money 74
4-4 Two Alternative ways of looking at the Equilibrium 79
The Federal Funds Market and the
Federal Funds Rate 79 • The Supply of
Money, the Demand for Money, and the
Money Multiplier 80 • Understanding the
Money Multiplier 80
vi
Contents
Contents vii
Chapter 5 Goods and Financial Markets: The IS-LM Model 85
5-1 The Goods Market and the IS
Relation 86
Investment, Sales, and the Interest
Rate 86 • Determining Output 87 • Deriving the IS Curve 89 • Shifts of the IS Curve 89
5-2 Financial Markets and the LM
Relation 90 Real Money, Real Income, and the Interest Rate 90 • Deriving the LM Curve 91 • Shifts of the LM
Curve 92
5-3 Putting the IS and the LM Relations
Together 93
Fiscal Policy, Activity, and the Interest Rate 94 • Monetary Policy, Activity, and the Interest Rate 96
5-4 Using a Policy Mix 98
5-5 How Does the IS-LM Model Fit the Facts? 102
Appendix: An Alternative Derivation
of the LM Relation as an Interest Rate Rule 107
The Medium Run 109
Chapter 6 The Labor Market 111
6-1 A Tour of the Labor Market 112
The Large Flows of Workers 112
6-2 Movements in Unemployment 115
6-3 Wage Determination 117
Bargaining 118 • Efficiency
Wages 119 • Wages, Prices, and
Unemployment 120 • The Expected
Price Level 120 • The Unemployment
Rate 121 • The Other Factors 121
6-4 Price Determination 122
6-5 The Natural Rate of Unemployment 122
The Wage-Setting Relation 123 •
The Price–Setting Relation 123 •
Equilibrium Real Wages and Unemployment 124 • From
Unemployment to Employment 125 •
From Employment to Output 126
6-6 Where We Go from Here 127
Appendix: Wage- and Price-Setting
Relations versus Labor Supply and Labor
Demand 131
Chapter 7 Putting All Markets Together:
The AS–AD Model 133
7-1 Aggregate Supply 134
7-2 Aggregate Demand 136
7-3 Equilibrium in the Short Run and in the Medium Run 139
Equilibrium in the Short Run 139 • From the Short Run to the Medium Run 140
7-4 The Effects of a Monetary
Expansion 142
The Dynamics of Adjustment 142 •
Going Behind the Scenes 143 • The
Neutrality of Money 144
7-5 A Decrease in the Budget
Deficit 146
Deficit Reduction, Output, and the
Interest Rate 147 • Budget Deficits,
Output, and Investment 148
7-6 An Increase in the Price of Oil 149 Effects on the Natural Rate of
Unemployment 150 • The Dynamics of
Adjustment 151
7-7 Conclusions 154
The Short Run versus the Medium
Run 154 • Shocks and Propagation
Mechanisms 155 • Where We Go from
Here 156
Chapter 8 The Phillips Curve, the Natural
Rate of Unemployment, and Inflation 161
8-1 Inflation, Expected Inflation, and
Unemployment 162
8-2 The Phillips Curve 164
The Early Incarnation 164 •
Mutations 164 • The Phillips
Curve and the Natural Rate of Unemployment 169 • The Neutrality of Money, Revisited 171
8-3 A Summary and Many
Warnings 171
Variations in the Natural Rate across
Countries 172 • Variations in the Natural
Rate over Time 172 • Disinflation,
Credibility, and Unemployment 172 •
High Inflation and the Phillips Curve
Relation 177 • Deflation and the Phillips
Curve Relation 178
Appendix: From the Aggregate
Supply Relation to a Relation between
Inflation, Expected Inflation, and
Unemployment 182
viii Contents
Chapter 9 The Crisis 183
9-1 From a Housing Problem to a
Financial Crisis 184
Housing Prices and Subprime
Mortgages 184 • The Role of
Banks 185
9-2 The Use and Limits of Policy 189 Initial Policy Responses 191 • The Limits of Monetary Policy: The Liquidity Trap 192 • The Limits of Fiscal Policy:
High Debt 196
9-3 The Slow Recovery 196
The Long Run 205
Chapter 10 The Facts of Growth 207
10-1 Measuring the Standard of Living 208
10-2 Growth in Rich Countries since
1950 211
The Large Increase in the Standard of Living since 1950 213 • The Convergence of Output per Person 214
10-3 A Broader Look across Time and
Space 215
Looking across Two Millennia 215 •
Looking across Countries 215
10-4 Thinking About Growth:
A Primer 217
The Aggregate Production
Function 217 • Returns to Scale and Returns to Factors 218 • Output per Worker and Capital per Worker 219 • The Sources of
Growth 220
Chapter 11 Saving, Capital Accumulation, and Output 225
11-1 Interactions between Output and Capital 226
The Effects of Capital on
Output 226 • The Effects of Output on
Capital Accumulation 227
11-2 The Implications of Alternative
Saving Rates 229
Dynamics of Capital and
Output 229 • Steady-State Capital and
Output 232 • The Saving Rate and
Output 232 • The Saving Rate and
Consumption 235
11-3 Getting a Sense of Magnitudes 238 The Effects of the Saving Rate on
Steady-State Output 238 • The
Dynamic Effects of an Increase in the Saving Rate 239 • The U.S. Saving Rate and the Golden Rule 241
11-4 Physical versus Human
Capital 242
Extending the Production
Function 242 • Human Capital, Physical
Capital, and Output 243 • Endogenous
Growth 244
Appendix: The Cobb-Douglas Production
Function and the Steady State 247
Chapter 12 Technological Progress and
Growth 249
12-1 Technological Progress and the Rate of Growth 250
Technological Progress and the Production Function 250 • Interactions between Output and Capital 252 • Dynamics of Capital and Output 254 • The Effects of the Saving Rate 255
12-2 The Determinants of Technological
Progress 256
The Fertility of the Research
Process 257 • The Appropriability of
Research Results 258
12-3 The Facts of Growth Revisited 260 Capital Accumulation versus Technological Progress in Rich Countries since 1985 260 • Capital Accumulation versus Technological Progress in China 261
Appendix: Constructing a Measure of
Technological Progress 265
Chapter 13 Technological Progress:
The Short, the Medium, and the Long Run 267
13-1 Productivity, Output, and
Unemployment in the Short
Run 268
Technological Progress,
Aggregate Supply, and Aggregate
Demand 268 • The Empirical
Evidence 270
13-2 Productivity and the Natural Rate of
Unemployment 272
Price Setting and Wage Setting
Revisited 272 • The Natural Rate of
Unemployment 273 • The Empirical
Evidence 274
Contents ix
13-3 Technological Progress, Churning, and Distribution Effects 276 The Increase in Wage Inequality 279 •
The Causes of Increased Wage
Inequality 279
13-4 Institutions, Technological Progress, and Growth 281
EXTENSIONS
Expectations 289
Chapter 14 Expectations:
The Basic Tools 291
14-1 Nominal versus Real Interest
Rates 292
Nominal and Real Interest Rates in the
United States since 1978 294
14-2 Nominal and Real Interest Rates, and the IS–LM Model 297
14-3 Money Growth, Inflation, Nominal and Real Interest Rates 298 Revisiting the IS–LM Model 298 • Nominal and Real Interest Rates in the Short Run 298 • Nominal and Real Interest Rates in the Medium Run 300 • From the Short to the Medium Run 301 • Evidence on the Fisher Hypothesis 302
14-4 Expected Present Discounted
Values 304
Computing Expected Present
Discounted Values 305 • Using Present Values: Examples 307 • Nominal versus Real Interest Rates, and Present Values 308
Appendix: Deriving the Expected Present Discounted Value Using Real or
Nominal Interest Rates 311
Chapter 15 Financial Markets and
Expectations 313
15-1 Bond Prices and Bond Yields 314 Bond Prices as Present
Values 315 • Arbitrage and Bond
Prices 316 • From Bond Prices to
Bond Yields 318 • Interpreting the
Yield Curve 319 • The Yield Curve and
Economic Activity 319
15-2 The Stock Market and Movements in
Stock Prices 322
Stock Prices as Present
Values 323 • The Stock Market
and Economic Activity 325 • A Monetary Expansion and the Stock
Market 326 • An Increase in Consumer Spending and the Stock Market 327
15-3 Risk, Bubbles, Fads, and Asset
Prices 328
Stock Prices and Risk 328 • Asset
Prices, Fundamentals, and Bubbles 330
Chapter 16 Expectations, Consumption, and Investment 337
16-1 Consumption 337
The Very Foresighted Consumer 338 •
An Example 338 • Toward a More Realistic Description 340 • Putting
Things Together: Current Income,
Expectations, and Consumption 343
16-2 Investment 344
Investment and Expectations of
Profit 344 • A Convenient Special
Case 346 • Current versus Expected
Profit 348 • Profit and Sales 350
16-3 The Volatility of Consumption and Investment 352
Appendix: Derivation of the Expected
Present Value of Profits under Static
Expectations 356
Chapter 17 Expectations, Output, and
Policy 357
17-1 Expectations and Decisions: Taking
Stock 358
Expectations, Consumption, and Invest- ment Decisions 358 • Expectations and the IS Relation 358 • The LM Relation Revisited 361
17-2 Monetary Policy, Expectations, and
Output 362
From the Short Nominal Rate to Current and Expected Real Rates 362 • Monetary Policy Revisited 363
17-3 Deficit Reduction, Expectations, and
Output 367
The Role of Expectations about the
Future 368 • Back to the Current
Period 369
The Open Economy 377
Chapter 18 Openness in Goods and Financial
Markets 379
18-1 Openness in Goods Markets 380 Exports and Imports 380 • The Choice between Domestic Goods and Foreign
x Contents
Goods 382 • Nominal Exchange
Rates 382 • From Nominal to Real
Exchange Rates 383 • From Bilateral to
Multilateral Exchange Rates 387
18-2 Openness in Financial Markets 388 The Balance of Payments 389 • The
Choice between Domestic and Foreign
Assets 391 • Interest Rates and
Exchange Rates 393
18-3 Conclusions and a Look Ahead 395
Chapter 19 The Goods Market in an Open
Economy 399
19-1 The IS Relation in the Open
Economy 400
The Demand for Domestic Goods 400 •
The Determinants of C, I and G 400 •
The Determinants of Imports 401 • The Determinants of Exports 401 • Putting the Components Together 401
19-2 Equilibrium Output and the Trade Balance 403
19-3 Increases in Demand, Domestic or
Foreign 404
Increases in Domestic Demand 404 •
Increases in Foreign Demand 406 •
Fiscal Policy Revisited 407
19-4 Depreciation, the Trade Balance, and Output 409
Depreciation and the Trade Balance:
The Marshall-Lerner Condition 410 •
The Effects of a Depreciation 410 •
Combining Exchange Rate and Fiscal
Policies 411
19-5 Looking at Dynamics: The J-Curve 413
19-6 Saving, Investment, and the Current Account Balance 415
Appendix: Derivation of the Marshall-
Lerner Condition 421
Chapter 20 Output, the Interest Rate, and the
Exchange Rate 423
20-1 Equilibrium in the Goods Market 424
20-2 Equilibrium in Financial
Markets 425
Money versus Bonds 425 • Domestic
Bonds versus Foreign Bonds 426
20-3 Putting Goods and Financial
Markets Together 428
20-4 The Effects of Policy in an Open
Economy 431
The Effects of Fiscal Policy in an Open
Economy 431 • The Effects of Monetary
Policy in an Open Economy 433
20-5 Fixed Exchange Rates 435
Pegs, Crawling Pegs, Bands, the EMS, and the Euro 435 • Pegging the Exchange Rate, and Monetary Control 436 • Fiscal Policy under Fixed
Exchange Rates 437
Appendix: Fixed Exchange Rates, Interest
Rates, and Capital Mobility 442
Chapter 21 Exchange Rate Regimes 445
21-1 The Medium Run 446
Aggregate Demand under Fixed Exchange Rates 447 • Equilibrium in the Short Run and in the Medium Run 448 • The Case For and Against a
Devaluation 450
21-2 Exchange Rate Crises under Fixed Exchange Rates 451
21-3 Exchange Rate Movements under
Flexible Exchange Rates 455
Exchange Rates and the Current Account 457 • Exchange Rates and Current and Future Interest
Rates 457 • Exchange Rate
Volatility 457
21-4 Choosing between Exchange Rate
Regimes 459
Common Currency Areas 459 • Hard
Pegs, Currency Boards, and
Dollarization 462
Appendix 1: Deriving Aggregate
Demand under Fixed Exchange
Rates 467
Appendix 2: The Real Exchange Rate and Domestic and Foreign Real Interest Rates 468
Back to Policy 471
Chapter 22 Should Policy Makers Be
Restrained? 473
22-1 Uncertainty and Policy 474
How Much Do Macroeconomists
Actually Know? 474 • Should
Contents xi
24-3 The Design of Monetary Policy 524 Money Growth Targets and Target
Ranges 525 • Inflation Targeting 526 •
Interest Rate Rules 529
24-4 Challenges from the Crisis 530 The Liquidity Trap 530 • Macro
Prudential Regulation 532
Chapter 25 Epilogue: The Story of
Macroeconomics 539
25-1 Keynes and the Great Depression 540
25-2 The Neoclassical Synthesis 540 Progress on All Fronts 541 • Keynesians versus Monetarists 542
25-3 The Rational Expectations
Critique 543
The Three Implications of Rational
Expectations 544 • The Integration of
Rational Expectations 545
25-4 Developments in Macroeconomics to the 2009 Crisis 547 New Classical Economics and Real
Business Cycle Theory 547 • New
Keynesian Economics 548 • New
Growth Theory 549 • Toward an
Integration 549
25-5 First Lessons for Macro-economics after the Crisis 550
Appendix 1 An Introduction to National
Income and Product
Accounts A-1
Appendix 2 A Math Refresher A-7
Appendix 3 An Introduction to
Econometrics A-12
Glossary G-1
Index I-1
Credits C-1
Uncertainty Lead Policy Makers to Do Less? 477 • Uncertainty and Restraints on Policy Makers 477
22-2 Expectations and Policy 478
Hostage Takings and Negotiations 479 •
Inflation and Unemployment
Revisited 479 • Establishing
Credibility 480 • Time Consistency and
Restraints on Policy Makers 482
22-3 Politics and Policy 482
Games between Policy Makers and
Voters 483 • Games between Policy
Makers 484 • Politics and Fiscal
Restraints 485
Chapter 23 Fiscal Policy: A Summing Up 493
23-1 What We Have Learned 494
23-2 The Government Budget Constraint:
Deficits, Debt, Spending, and
Taxes 495
The Arithmetic of Deficits and
Debt 495 • Current versus Future Taxes 497 • The Evolution of the
Debt-to-GDP Ratio 500
23-3 Ricardian Equivalence, Cyclical
Adjusted Deficits, and War
Finance 502
Ricardian Equivalence 502 • Deficits,
Output Stabilization, and the Cyclically
Adjusted Deficit 503 • Wars and
Deficits 504
23-4 The Dangers of High Debt 506 High Debt, Default Risk, and Vicious
Cycles 506 • Debt Default 509 • Money
Finance 510
Chapter 24 Monetary Policy:
A Summing Up 517
24-1 What We Have Learned 518
24-2 The Optimal Inflation Rate 519 The Costs of Inflation 520 • The Benefits of Inflation 522 • The Optimal Inflation Rate: The Current Debate 524
