Macroeconomics

Cover......Page 1
Title Page......Page 3
Copyright Page......Page 4
About the Authors......Page 5
Preface......Page 20
Contents......Page 7
WHEN YOU ENTER THE JOB MARKET CAN MATTER A LOT......Page 35
Macroeconomics in the Short Run and in the Long Run......Page 36
Long-Run Growth in the United States......Page 37
Some Countries Have Not Experienced Significant Long-Run Growth......Page 38
Aging Populations Pose a Challenge to Governments Around the World......Page 39
Unemployment in the United States......Page 40
Inflation Rates Fluctuate Over Time and Across Countries......Page 41
Economic Policy Can Help Stabilize the Economy......Page 42
International Factors Have Become Increasingly Important in Explaining Macroeconomic Events......Page 43
What Is the Best Way to Analyze Macroeconomic Issues?......Page 45
Solved Problem 1.2: Do Rising Imports Lead to a Permanent Reduction in U.S. Employment?......Page 46
Assumptions, Endogenous Variables, and Exogenous Variables in Economic Models......Page 47
Forming and Testing Hypotheses in Economic Models......Page 48
Making the Connection: What Do People Know About Macroeconomics and How Do They Know It?......Page 49
1.3 Key Issues and Questions of Macroeconomics......Page 50
An Inside Look: Will Consumer Spending Nudge Employers to Hire?......Page 52
Review Questions......Page 54
Problems and Applications......Page 55
Data Exercise......Page 56
Key Issue and Question......Page 57
How the Government Calculates GDP......Page 59
Production and Income......Page 60
The Circular Flow of Income......Page 61
National Income Identities and the Components of GDP......Page 63
Making the Connection: Will Public Employee Pensions Wreck State and Local Government Budgets?......Page 65
2.2 Real GDP, Nominal GDP, and the GDP Deflator......Page 67
Solved Problem 2.2a: Calculating Real GDP......Page 68
Price Indexes and the GDP Deflator......Page 69
Solved Problem 2.2b: Calculating the Inflation Rate......Page 70
Making the Connection: Trying to Hit a Moving Target: Forecasting with “Real-Time Data”......Page 71
Comparing GDP Across Countries......Page 72
Making the Connection: The Incredible Shrinking Chinese Economy......Page 73
GDP and National Income......Page 74
2.3 Inflation Rates and Interest Rates......Page 75
The Consumer Price Index......Page 76
Making the Connection: Does Indexing Preserve the Purchasing Power of Social Security Payments?......Page 77
The Way the Federal Reserve Measures Inflation......Page 78
Interest Rates......Page 79
2.4 Measuring Employment and Unemployment......Page 81
Answering the Key Question......Page 83
An Inside Look: Weak Construction Market Persists......Page 84
Review Questions......Page 86
Problems and Applications......Page 87
Data Exercise......Page 91
Key Issue and Question......Page 93
3.1 Overview of the Financial System......Page 94
Financial Markets and Financial Intermediaries......Page 95
Making the Connection: Is General Motors Making Cars or Making Loans?......Page 96
Making the Connection: Investing in the Worldwide Stock Market......Page 98
The Mortgage Market and the Subprime Lending Disaster......Page 101
Asymmetric Information and Principal–Agent Problems in Financial Markets......Page 102
Central Banks as Lenders of Last Resort......Page 103
Bank Runs, Contagion, and Asset Deflation......Page 104
Making the Connection: Panics Then and Now: The Collapse of the Bank of United States in 1930 and the Collapse of Lehman Brothers in 2008......Page 105
Saving and Supply in the Loanable Funds Market......Page 110
Investment and the Demand for Loanable Funds......Page 111
Explaining Movements in Saving, Investment, and the Real Interest Rate......Page 112
Solved Problem 3.3: Using the Loanable Funds Model to Analyze the U.S. Economy in 2010......Page 115
Shifts in the Money Demand Curve......Page 116
Equilibrium in the Market for Money......Page 118
The Concept of Present Value......Page 119
Present Value and the Prices of Stocks and Bonds......Page 121
The Economy’s Many Interest Rates......Page 123
Answering the Key Question......Page 127
An Inside Look: Credit Market Easing for Small Businesses......Page 128
Problems and Applications......Page 130
Data Exercise......Page 135
Appendix: More on the Term Structure of Interest Rates......Page 137
Key Issue and Question......Page 139
4.1 The Aggregate Production Function......Page 140
The Cobb–Douglas Production Function......Page 141
The Marginal Products of Capital and Labor......Page 143
Solved Problem 4.1: Calculating the Marginal Product of Labor and the Marginal Product of Capital......Page 145
Calculating Total Factor Productivity......Page 147
Making the Connection: Foreign Direct Investment Increases Real GDP Growth in China......Page 148
The Markets for Capital and Labor......Page 150
Combining the Factor Markets with the Aggregate Production Function......Page 152
Aggregation......Page 153
4.3 Accounting for Growth in Real GDP......Page 154
Accounting for Real GDP Growth......Page 155
Accounting for Labor Productivity Growth......Page 156
Solved Problem 4.3: Accounting for Labor Productivity Growth......Page 157
Making the Connection: What Explains Recent Economic Growth in India?......Page 158
Total Factor Productivity as the Ultimate Source of Growth......Page 159
4.4 GDP per Hour Worked Among Countries......Page 161
Making the Connection: Will Indian Workers Become More Productive Than U.S. Workers?......Page 163
A Numerical Example......Page 164
Answering the Key Question......Page 165
An Inside Look: GM Expanding Production in India......Page 166
Problems and Applications......Page 168
Data Exercise......Page 173
Deriving the Marginal Product of Labor......Page 174
Deriving the Growth Accounting Equation for the Real GDP per Hour Worked Form of the Production Function......Page 175
Showing That the Rate of Return to Capital Is Equal to the Marginal Product of the Capital–Labor Ratio......Page 176
Key Issue and Question......Page 177
5.1 Labor Productivity and the Standard of Living......Page 178
The Two Components of Real GDP per Capita......Page 179
Solved Problem 5.1: Explaining Increases in Real GDP per Capita......Page 180
Challenges with Using Real GDP per Capita as a Measure of the Standard of Living......Page 181
5.2 The Solow Growth Model......Page 185
Capital Accumulation......Page 187
Equilibrium and the Steady State......Page 188
The Saving Rate and Real GDP per Hour Worked......Page 191
Macro Data: What Are the Long-Run Effects of Government Budget Deficits?......Page 192
Depreciation, the Labor Force Growth Rate, and Real GDP per Hour Worked......Page 193
Solved Problem 5.2: A Decrease in the Labor Force Growth Rate and Real GDP per Hour Worked......Page 194
Total Factor Productivity and Real GDP per Hour Worked......Page 196
Making the Connection: Research and Development Expenditures and Labor Productivity Differences Between China and the United States......Page 198
Making the Connection: How Important Were the Chinese Economic Reforms of 1978?......Page 201
Convergence to the Balanced Growth Path......Page 202
Making the Connection: Will China’s Standard of Living Ever Exceed that of the United States?......Page 204
Do All Countries Converge to the Same Balanced Growth Path?......Page 206
Answering the Key Question......Page 207
An Inside Look: Will India Catch Up With China?......Page 208
Problems and Applications......Page 210
Data Exercise......Page 215
Appendix A: Capital Accumulation and Endogenous Growth......Page 216
The Evidence on Endogenous Growth Theory......Page 217
Capital–Labor Ratio......Page 219
Real GDP......Page 220
Key Issue and Question......Page 222
The Functions of Money......Page 223
Commodity Money Versus Fiat Money......Page 225
Making the Connection: When Money Is No Longer Money: Hyperinflation in Zimbabwe......Page 226
How Is Money Measured?......Page 227
6.2 The Federal Reserve and the Money Supply......Page 228
The Process of Money Creation......Page 229
6.3 The Quantity Theory of Money and Inflation......Page 231
The Quantity Theory Explanation of Inflation......Page 232
Making the Connection: Is the Inflation Rate Around the World Going to Increase in the Near Future?......Page 233
Can the Quantity Theory Accurately Predict the Inflation Rate?......Page 234
The Fisher Effect......Page 236
Money Growth and the Nominal Interest Rate......Page 238
Solved Problem 6.4: The Effect of an Increase in the Growth Rate of the Money Supply on the Interest Rate......Page 239
Costs of Expected Inflation......Page 240
Costs of Unexpected Inflation......Page 242
Macro Data: What Is the Expected Inflation Rate?......Page 243
Making the Connection: Did the Fed’s Actions During the Financial Crisis of 2007–2009 Increase the Expected Inflation Rate?......Page 244
Benefits of Inflation......Page 245
6.6 Hyperinflation and Its Causes......Page 246
German Hyperinflation After World War I......Page 247
Answering the Key Question......Page 249
An Inside Look at Policy: Growing Economy Fuels Inflation Concerns in China......Page 250
Problems and Applications......Page 252
Data Exercise......Page 258
Open Market Operations......Page 260
The Simple Deposit Multiplier......Page 261
A More Realistic Money Multiplier......Page 263
Appendix B: The Growth Rate Version of the Quantity Equation......Page 264
Key Issue and Question......Page 265
7.1 The Labor Market......Page 266
Shifting the Demand Curve......Page 267
The Supply of Labor Services......Page 269
Equilibrium in the Labor Market......Page 270
Solved Problem 7.1: The Effect of Increased Wealth on the Aggregate Labor Market......Page 272
Unemployment Around the World......Page 273
Frictional Unemployment and Job Search......Page 274
Structural Unemployment......Page 275
Macro Data: Is the Decline of Goods-Producing Industries a Recent Phenomenon?......Page 276
Cyclical Unemployment......Page 277
Making the Connection: Did the Structural Unemployment Rate Rise During the Recession of 2007–2009?......Page 278
Full Employment......Page 279
7.3 The Natural Rate of Unemployment......Page 280
Solved Problem 7.3: How Many Jobs Does the U.S. Economy Create Every Month?......Page 281
The Natural Rate of Unemployment in the United States......Page 283
Efficiency Wages......Page 287
Labor Unions Around the World......Page 288
Minimum Wage Laws......Page 289
Monetary Policy, Unemployment, and the Classical Dichotomy......Page 290
7.5 Comparisons of Unemployment Rates in Western Europe and the United States......Page 291
Strength of Labor Unions......Page 292
Making the Connection: Job Security and Job Hiring at France Télécom SA......Page 293
Answering the Key Question......Page 295
An Inside Look: Unemployment Rate Falls, yet Remains Significantly Lower than Underemployment Rate......Page 296
Problems and Applications......Page 298
Data Exercise......Page 304
Key Issue and Question......Page 305
8.1 The Short Run and the Long Run in Macroeconomics......Page 306
Macroeconomic Shocks and Price Flexibility......Page 307
Why Are Prices Sticky in the Short Run?......Page 308
Making the Connection: The Curious Case of the 5-Cent Coke......Page 309
Making the Connection: Union Contracts and the U.S. Automobile Industry......Page 311
8.2 What Happens During a Business Cycle?......Page 312
The Changing Severity of the U.S. Business Cycle......Page 313
Measuring Business Cycles......Page 315
Solved Problem 8.2: Dating U.S. Recessions......Page 316
Costs of the Business Cycle......Page 317
Making the Connection: Did the 2007–2009 Recession Break Okun’s Law?......Page 319
Movements of Economic Variables During the Business Cycle......Page 322
The Global Business Cycle......Page 323
Multiplier Effects......Page 324
An Example of a Shock with Multiplier Effects......Page 326
Answering the Key Question......Page 327
An Inside Look: New Vehicle Sales Increase by 11 Percent in 2010......Page 328
Problems and Applications......Page 330
Data Exercise......Page 333
Appendix: The Formula for the Expenditure Multiplier......Page 335
Key Issue and Question......Page 336
Equilibrium in the Goods Market......Page 338
The Multiplier Effect......Page 341
Constructing the IS Curve......Page 343
Shifts of the IS Curve......Page 344
The IS Curve and the Output Gap......Page 345
9.2 The Monetary Policy Curve: The Relationship Between the Central Bank’s Target Interest Rate and Output......Page 346
The Link Between the Short-Term Nominal Interest Rate and Long-Term Real Interest Rate......Page 347
Deriving the MP Curve Using the Money Market Model......Page 349
Shifts of the MP Curve......Page 351
Monetary Policy and Fluctuations in Real GDP......Page 353
Demand Shocks and Fluctuations in Output......Page 355
Making the Connection: The Bankruptcy of Lehman Brothers, the Financial Crisis, and the Financing of Investment......Page 356
Solved Problem 9.3: Using the IS–MP Model to Analyze the 2001 Tax Cut......Page 359
9.4 The IS–MP Model and the Phillips Curve......Page 361
Okun’s Law and an Output Gap Phillips Curve......Page 364
Movement Along an Existing Phillips Curve......Page 367
How Well Does the Phillips Curve Fit the Inflation Data?......Page 368
Using Monetary Policy to Fight a Recession......Page 369
Solved Problem 9.4: Fed Policy to Keep Inflation from Increasing......Page 370
The IS–MP Model and the Financial and Real Estate Shocks......Page 373
The IS–MP Model and the Oil Shock of 2007–2008......Page 376
Answering the Key Question......Page 377
An Inside Look at Policy: Largest Financial Overhaul Package since Great Depression Signed Into Law......Page 378
Problems and Applications......Page 380
Data Exercise......Page 386
Asset Market Equilibrium......Page 387
Deriving the LM Curve......Page 388
Shifting the LM Curve......Page 389
Equilibrium in the IS–LM Model......Page 390
Solved Problem 9A.1: Monetary Policy During the Great Depression......Page 393
An Alternative Derivation of the MP Curve......Page 394
Key Issue and Question......Page 397
Creation of the Federal Reserve System......Page 399
The Structure of the Federal Reserve System......Page 400
Price Stability......Page 401
Economic Growth......Page 402
Foreign-Exchange Market Stability......Page 403
Open Market Operations......Page 404
Macro Data: Does the Federal Reserve Hit Its Federal Funds Rate Target?......Page 405
Reserve Requirements......Page 406
New Monetary Policy Tools in Response to the 2007–2009 Financial Crisis......Page 407
Making the Connection: On the Board of Governors, Four Can Be a Crowd......Page 409
Monetary Policy and Aggregate Expenditure......Page 410
Using Monetary Policy to Deal with a Supply Shock......Page 412
Solved Problem 10.4: Did the Federal Reserve Make the Great Depression Worse?......Page 415
Alternative Channels of Monetary Policy......Page 417
Policy Lags......Page 420
Economic Forecasts......Page 421
Consequences of Policy Limitations......Page 422
Solved Problem 10.5: Did the Fed Help Cause the 2001 Recession?......Page 423
Making the Connection: “Too Big to Fail”—The Legacy of Continental Illinois......Page 427
The Independence of the U.S. Federal Reserve......Page 428
Answering the Key Question......Page 431
An Inside Look at Policy: Will the Fed Reverse Its Current Monetary Policy?......Page 432
Problems and Applications......Page 434
Data Exercise......Page 440
Key Issue and Question......Page 441
11.1 The Goals and Tools of Fiscal Policy......Page 442
Traditional Tools of Fiscal Policy......Page 443
TARP: An Unconventional Fiscal Policy During the 2007–2009 Financial Crisis......Page 445
Making the Connection: Why Was the Severity of the 2007–2009 Recession So Difficult to Predict?......Page 446
The Budget Deficit and the Budget Surplus......Page 448
Making the Connection: How Did the Federal Government Run a Budget Surplus in the Late 1990s and early 2000s?......Page 449
Macro Data: Did Fiscal Policy Fail During the Great Depression?......Page 452
Is the Federal Debt a Problem?......Page 453
Using Discretionary Fiscal Policy to Fight a Recession......Page 455
Automatic Stabilizers......Page 457
Solved Problem 11.3A: Should the Government Reduce the Budget Deficit During a Recession?......Page 459
Making the Connection: State and Local Government Spending During the 2007–2009 Recession......Page 461
Personal Income Tax Rates and the Multiplier......Page 462
The Effects of Changes in Tax Rates on Potential GDP......Page 464
Policy Lags......Page 466
Economic Forecasts......Page 467
Crowding Out and Forward-Looking Households......Page 468
Moral Hazard......Page 470
The American Recovery and Reinvestment Act: An Early Evaluation......Page 471
Answering the Key Question......Page 473
An Inside Look at Policy: Obama Advisor Claims Stimulus Package Successful Despite Original Unemployment Projections......Page 474
Problems and Applications......Page 476
Data Exercise......Page 481
Key Issue and Question......Page 482
Monetary Policy Rules......Page 484
The Aggregate Demand Curve......Page 485
Shifts of the Aggregate Demand Curve......Page 486
When Are Shifts to the Aggregate Demand Curve Permanent?......Page 488
12.2 Aggregate Supply and the Phillips Curve......Page 490
Shifts in the Aggregate Supply Curve......Page 491
The Effects of a Supply Shock......Page 493
The Effect of a Change in the Monetary Policy Rule......Page 495
Macro Data: Are Oil Supply Shocks Really That Important?......Page 496
Making the Connection: The End of Stagflation and the Volcker Recession......Page 498
The Effect of a Demand Shock......Page 499
Solved Problem 12.3: Apply the AD–AS Model to an Increase in Housing Construction......Page 501
12.4 Rational Expectations and Policy Ineffectiveness......Page 503
Rational Expectations and Unanticipated Policy Changes......Page 504
Are Anticipated and Credible Policy Changes Actually Ineffective?......Page 505
The Taylor Rule......Page 506
The Taylor Rule and the Real Interest Rate......Page 508
The Case for Rules......Page 509
Making the Connection: Central Banks Around the World Try Inflation Targeting......Page 510
Answering the Key Question......Page 511
An Inside Look at Policy: Has the Fed Successfully Stimulated the Economy?......Page 512
Problems and Applications......Page 514
Data Exercise......Page 519
Key Issue and Question......Page 520
The Government Budget Constraint......Page 522
What Is the Difference Between the Debt and the Deficit?......Page 523
Gross Federal Debt Versus Debt Held by the Public......Page 524
Composition of Federal Government Revenue and Expenditure......Page 526
13.2 The Sustainability of Fiscal Policy......Page 528
Making the Connection: The European Debt Crisis......Page 529
When Is Fiscal Policy Sustainable?......Page 530
Solved Problem 13.2: Can Japan Grow Its Way Out of Debt?......Page 531
A Useful Identity......Page 532
The Conventional View: Crowding Out Private Investment......Page 533
Solved Problem 13.3: The Effect of a Government Budget Surplus......Page 535
Ricardian Equivalence......Page 537
Foreign-Sector Adjustments......Page 538
Projections of Federal Government Revenue and Expenditure......Page 539
Making the Connection: The U.S. National Commission on Fiscal Responsibility and Reform......Page 540
Policy Options......Page 541
Answering the Key Question......Page 545
An Inside Look at Policy: Senators Display Bipartisan Effort to Reduce Deficit......Page 546
Problems and Applications......Page 548
Data Exercise......Page 552
Appendix: Showing the Conditions for a Sustainable Fiscal Policy......Page 553
Key Issue and Question......Page 555
14.1 The Macroeconomic Implications of Microeconomic Decision Making: Intertemporal Choice......Page 556
The Critical Role of the Financial System in Consumption and Investment......Page 557
Consumption and GDP......Page 558
The Intertemporal Budget Constraint and Consumption Smoothing......Page 560
Two Theories of Consumption Smoothing......Page 561
Permanent Versus Transitory Changes in Income......Page 563
Consumption and the Real Interest Rate......Page 564
Housing Wealth and Consumption......Page 565
How Policy Affects Consumption......Page 566
Solved Problem 14.2: Effects of a Temporary Tax Cut......Page 567
Credit Rationing of Households......Page 568
Making the Connection: The Temporary Cut in Payroll Taxes......Page 570
Precautionary Saving......Page 571
Tax Incentives and Saving......Page 572
The Investment Decisions of Firms......Page 573
Corporate Taxes and the Desired Capital Stock......Page 577
Macro Data: How Important Are Corporate Taxes for Investment?......Page 578
From the Desired Capital Stock to Investment......Page 580
Solved Problem 14.3: Depreciation, Taxes, and Investment Spending......Page 581
Tobin’s q: Another Framework for Explaining Investment......Page 582
Credit Rationing and the Financial Accelerator......Page 583
Uncertainty and Irreversible Investment......Page 584
Answering the Key Question......Page 585
An Inside Look at Policy: Extension of Tax Cuts to Impact Families, Workers, and Employers......Page 586
Problems and Applications......Page 588
Data Exercise......Page 592
Key Issue and Question......Page 593
15.1 The Balance of Payments......Page 595
The Current Account......Page 597
The Financial Account......Page 598
15.2 The Balance of Payments and National Income Accounting......Page 599
Why Is the United States Called the World’s Largest Debtor Nation?......Page 600
15.3 Nominal and Real Exchange Rates......Page 602
Real Exchange Rates......Page 604
Purchasing Power Parity......Page 605
Types of Foreign-Exchange Systems......Page 606
The Foreign-Exchange Market......Page 608
Equilibrium in the Foreign-Exchange Market......Page 609
Changes in the Equilibrium Exchange Rate......Page 610
Solved Problem 15.4: The PIIGS and the Euro......Page 611
The IS Curve......Page 612
The Monetary Policy Curve......Page 613
Policy with a Floating Exchange Rate......Page 614
Solved Problem 15.5: Explaining the Effect of Deficit Reduction on Exchange Rates......Page 616
15.6 A Short-Run IS–MP Model of an Open Economy with a Fixed Exchange Rate......Page 618
Equilibrium with a Fixed Exchange Rate......Page 619
Policy with a Fixed Exchange Rate......Page 621
Exchange-Rate Stability......Page 623
The Policy Trilemma for Economic Policy......Page 624
Answering the Key Question......Page 627
An Inside Look at Policy: China Owns More U.S. Debt than Previously Thought......Page 628
Problems and Applications......Page 630
Data Exercise......Page 637
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