Macroeconomics: Institutions, Instability, and the Financial System

Reviews 
Preface 
How to use the Online Resource Centre 
Acknowledgements 
List of figures 
List of tables 
Abbreviations 

1 	The demand side 
	1.1 Overview 
	1.1.1 Facts about the demand side and business cycles 
	1.1.2 Introducing the IS curve 
	1.2 Modelling 
	1.2.1  Goods market equilibrium 
	1.2.2  The multiplier 
	1.2.3  The 15 curve 
	124  Forward—looking behaviour 
	1.2.5  Consumption 
	1.2.6  Investment 
	1.2.7  Consumption, investment and the IS curve 
	1.3 Conclusions 
	1.4 Appendix 
	141 Real and nominal interest rates and the Fisher equation 
	1.4.2 Deriving the Euler equation and the PIH consumption function 
	1.5 Questions 
	1.5.1 Checklist questions 
	1.5.2 Problems and questions for discussion 
2 	The supply side 
	2.1 Overview 
	2.1.1 Unemployment 
	2.1.2 Why the labour market does not clear 
	2.1.3 Supply side effects on unemployment 
	2.1.4 Nominal rigidities and demand-side policy 
	2.1.5 Facts about the supply side 
	2.2 Modelling 
	2.2.1 Supply side effects on unemployment 
	2.2.2 Nominal rigidities, inflation and the business cycle 
	2.3 Applications 
	2.4 Conclusions 
	2.5 Appendix
	2.5.1 The textbook model: competitive markets and complete contracts 
	2.5.2 The mark—up and the elasticity of demand 
	2.5.3 Deriving the PS curve including the tax wedge 
	2.6 Questions 
	2.6.1 Checklist questions 
	2.6.2 Problems and questions for discussion 
3 	The 3-equation model and macroeconomic policy 
	3.1 Overview 
	3.1.1 The role of the central bank in stabilization 
	3.1.2 Inflation and deflation 
	3.1.3 Introduction to the 3—equation model 
	3.2 Modelling 
	3.2.1 The 3-equation model 
	3.2.2 Using the 3-equation model 
	3.3 Applications 
	3.3.1  A temporary demand shock 
	3.3.2  Forecasting and lags 
	3.3.3  The deflation trap 
	3.3.4  A supply shock 
	3.4 Conclusions 
	3.5 Appendix 
	3.5.1 The 3-equation model in more detail 
	3.6 Questions 
	3.6.1 Checklist questions 
	3.6.2 Problems and questions for discussion 
4  	Expectations 
	4.1 Introduction 
	4.2 Risk, uncertainty and expectations 
	4.2.1 Risk and uncertainty 
	4.2.2 Expectations formation in real-world situations 
	4.2.3 The rational expectations hypothesis (REH) 
	4.3 Phillips curves, expectations and inflation 
	4.4 Expectations and the 3—equation model 
	4.4.1 A graphical example 
	4.4.2 Comparison of adaptive and rational inflation expectations 
	4.4.3 Central bank communication and anchoring inflation expectations 
	4.5 The Lucas critique 
	4.6 Expectations hypotheses, inflation bias and time inconsistency 
	4.6.1 Adaptive expections and inflation bias 
	4.6.2 Rational expectations, inflation bias and time inconsistency 
	4.6.3 Approaches to mitigate inflation bias 
	4.7 Conclusions 
	4.8 Questions 
	4.8.1 Checklist questions 
	4.8.2 Problems and questions for discussion 
5 	Money, banking and the macro-economy 
	5.1  Introduction
	5.2 Money and the macro—economy 
	5.2.1 Money 
	522 Money supply and money demand 
	5.2.3 Money, banks and the 3—equation model 
	5.3 A modern financial system 
	5.3.1 The central bank sets the policy interest rate 
	5.32 The mark—up of the lending rate over the policy rate 
	5.33 Banks, credit constraints and collateral 
	5.3.4 The role of banks in a fractional reserve system 
	5.3.5 Governance arrangements: banks, central bank and government 
	5.4 The financial system and balance sheets 
	5.5 Banks and macro stabilization 
	5.5.1 Example: an investment boom shifts the IS curve 
	5.6 Conclusions 
	5.7 Appendix 
	5.7.1 Modelling the banking mark—up (r — rP) 
	5.8  Questions 
	5.8.1 Checklistquestions 
	5.8.2 Problems and questions for discussion 
	The financial sector and crises 
	6.1 Introduction 
	6.2 Bank behaviour, cycles and crises 
	6.2.1 Bank behaviour and the macro—economy 
	6.2.2 Financial crises and their cost to the economy 
	623 Financial cycles and business cycles 
	6.3 Basic mechanisms 
	6.3.1 Asset price bubbles 
	6.3.2 The financial accelerator 
	6.4 The housing feedback process and the 3-equation model 
	641 Credit constrained households, housing collateral and house prices 
	642 A plain vanilla financial crisis 
	6.4.3 Housing feedback process and the 3-equation model 
	6.5 The bank leverage—centred feedback process 
	6.5.1  Investment bank behaviour and leverage 
	6.6 A balance sheet recession and the financial accelerator 
	6.7 Conclusions 
	6.8 Appendix 
	6.8.1 Modelling the housing—centred positive feedback process 
	6.8.2 A positive feedback model of investment bank behaviour 
	6.9 Questions 
	691 Checklistquestions 
	6.9.2 Problems and questions for discussion 
7 	The global financial crisis: applying the models 
	71 Introduction 
	7.2 Pre—crisis financial system: incentives, instruments and actors 
	7.2.1 Incentives 
7.2.2 lnstruments 
7.2.3 Actors 
7.3 The upswing of the financial cycle 
7.4 The crisis 
7.4.1 The scale of the crisis and nature of the post-crisis recession 
7.4.2 The credit crunch 
7.4.3 The crisis, macroeconomic policy and the 3-equation model 
7.5 Policy intervention in the crisis 
7.5.1  What went wrong in the Great Depression? 
7.5.2  Monetary and fiscal policy in the crisis phase 
753  Austerity policies in the post-crisis recession 
7.5.4  Fixing banks first may mean less government debt later 
7.6 Conclusions 
7.7 Questions 
7.7.1 Checklistquestions 
7.7.2 Problems and questions for discussion 
8  Growth, fluctuations and innovation 
8.1  Introduction 
8.2  Short- and medium-run macro models and growth theory 
8.3  Growth concepts and useful tools 
8.4  The Solow model 
8.4.1 The model 
8.4.2 Steady state or balanced growth 
8.5 The Solow model and cross-country performance 
8.6 Technological progress in the Solow model 
8.6.1 Technological progress and steady state growth 
8.6.2 Growth accounting: measuring the impact of technology 
8.7 Endogenous growth: the Romer model 
8.7.1 Research and development 
8.7.2 Endogenous growth and endogenous technological progress: the Romer model 
8.8 Schumpeterian growth: the Aghion—Howitt model 
8.8.1 Creative destruction, competition and Schumpeterian growth 
8.8.2 Schumpeterian growth and business cycle fluctuations 
8.9 Conclusions 
8.10 Questions 
810.1 Checklistquestions 
8.10.2 Problems and questions for discussion 
9 The 3-equation model in the open economy 
9.1 Overview 
9.2 Modelling 
9.2.1 The foreign exchange market and the UIP condition 
9.2.2 Medium-run equilibrium in the open economy and the AD — ERU model 
9.2.3 AD curve 
9.2.4 Stabilization under flexible exchange rates: 3-equation model and RX curve 
9.2.5 Inflation shock: Comparing closed and open economies 
9.3 Applications 
9.3.1 Demand and supply shocks: the 3—equation and AD—ERU models 
	9.3.2 Exchange rate overshooting 
	9.3.3 Exchange rate volatility 
	9.4 Conclusions 
	9.5 Appendix 
	9.5.1 Deriving the real UIP condition 
	9.5.2 The 3—equation model in more detail 
	9.5.3 Derivation of (1 — A) and its properties 
	9.5.4 Geometry ofthe RX curve: varying the parameters 
	9.6 Questions 
	9.6.1 Checklistquestions 
	9.6.2 Problems and questions for discussion 
\'IO 	The open economy: the demand and supply sides 
	10.1 Overview 
	10.1.1 The open economy accounting framework 
	10.1.2 The demand side, trade balance and the supply side 
	10.2 Modelling 
	10.2.1 The demand side and trade balance 
	10.2.2 The supply side in the open economy 
	10.2.3 The medium-run model: AD-BT—ERU 
	10.3 Application 
	10.3.1 The UK economy before the crisis 
	10.4 Conclusions 
	10.5 Appendix 
	10.6 Questions 
	10.6.1 Checklistquestions 
	1062 Problems and questions for discussion 
11 	Extending the open economy model: oil shocks and imbalances 
	11.1 Overview 
	11.11 How does a commodity price rise affect the macro—economy? 
	11.1.2 Interpreting an economy’s sector financial balances: does a current account 
	imbalance matter? 
	1113 Inflation targeting in a two-bloc world 
	1114 Different medium»run ’growth’ strategies can cause global imbalances 
	11.2 Modelling 
	11.2.1  Oil shocks 
	11.2.2  Current account imbalances 
	11.23  Sector financial balances 
	11.2.4  Global interdependence and imbalances 
	11.2.5  A 2—bloc model with inflation—targeting central banks 
	11.3 Conclusions 
	11.4 Appendix 
	1141 Dynamic adjustment to a shock in the 2—bloc model 
	11.5 Questions 
	1151 Checklist questions 
	11.5.2 Problems and questions for discussion 
12 	The Eurozone 
	12.1 Introduction 
	12.1.1 Origins of the Eurozone and the theory of an optimal currency area 
	12.1.2 The Eurozone’s performance in its first ten years 
	12.2 The Eurozone policy regime 
	12.2.1 The Maastricht policy assignment 
	12.2.2 Monetary policy in the Eurozone 
	12.2.3 Fiscal policy in the Eurozone 
	12.3 Stabilization in the Eurozone: common shocks 
	12.4 Stabilization in the Eurozone: country—specific shocks 
	12.4.1  ls stabilization policy necessary for country-specific shocks.7 
	12.4.2  The real exchange rate (competitiveness) channel 
	12.4.3  The real interest rate channel 
	12.4.4  Using fiscal policy to stabilize 
	12.4.5  The real exchange rate channel—internal devaluation 
	12.4.6  Conclusions about stabilization policy in the Eurozone 
	12.5 Eurozone governance, sovereign risk and the banking system 
	12.5.1 Governance arrangements: banks. governments and central bank 
	12.5.2 Governance solutions 
	12.6 Conclusions 
	12.7 Questions 
	12.7.1 Checklistquestions 
	12.7.2 Problems and questions for discussion 
13  	Monetary policy 
	13.1 Introduction 
	13.2 Monetary policy and the economy’s nominal anchor 
	13.2.1 The classical dichotomy and the nominal anchor 
	13.2.2 From theory to practice: monetary policy and inflation in the 19705 and 19805 
	132.3 The inflation target as the nominal anchor 
	13.3 Modelling 
	13.3.1 Active rule—based policy 
	13.3.2 Central bank preferences: sacrifice ratios and costly disinflation 
	13.3.3 The MR equation and Taylor rules 
	13.4 The modern monetary policy framework—practice 
	13.4.1 Taylor rules in practice 
	13.5 Monetary policy and the global financial crisis 
	13.5.1 Asset price bubbles and central bank intervention 
	13.5.2 Unorthodox monetary policy in the Great Recession 
	13.6  Post-crisis reform of financial regulation and the macro policy framework 
	13.6.1 The failures ofthe conventional macroeconomic policy framework 
	13.6.2 Post—crisis reforms for a safer financial system 
	13.7 Conclusions 
	13.8 Questions 
	13.8.1 Checklistquestions 
	13.8.2 Problems and questions for discussion 
14 	Fiscal policy 
	14.1 Introduction 
	14.2 Fiscal policy’s role in stabilization 
	14.2.1 The scope of fiscal policy 
	14.2.2 The effects ofdiscretionary fiscal policy 
	14.2.3 The automatic stabilizers 
	14.3 Debt dynamics 
	14.3.1  The government’s budget identity 
	14.3.2  Debt dynamics 
	14.3.3  The costs of high and rising government debt 
	14.3.4  Can fiscal consolidation be expansionary? 
	14.4 The government’s budget constraint and Ricardian equivalence 
	14.4.1 Ricardian equivalence and the PIH 
	14.4.2 Ricardian equivalence and fiscal policy effectiveness 
	14.5 Deficit bias and the political economy of debt 
	14.5.1 Causes ofdeficit bias 
	14.5.2 Why deficit bias may vary across countries 
	14.5.3 Approaches to tackle deficit bias 
	14.6 Conclusions 
	14.7 Questions 
	14.7.1 Checklistquestions 
	14.7.2 Problems and questions for discussion 
15  	Supply-side policy, institutions and unemployment 
	15.1  Introduction 
	15.2  Flows, matching and the Beveridge curve 
	15.3  Unions and wageAsetting arrangements 
	15.4  Efficiency wage models 
	15.41 A micro model of efficiency wage setting 
	15.4.2 What is the empirical evidence on efficiency wages? 
	15.5 Hysteresis and persistence in unemployment 
	15.6 Unemployment in OECD countries 
	15.6.1 Definitions: employment, unemployment and inactivity 
	15.6.2 Overview 
	15.6.3 Empirical studies 
	15.7 Labour market behaviour in the crisis 
	15.7.1 US unemployment during the crisis 
	15.7.2 European unemployment during the crisis 
	15.8 Conclusions 
	15.9 Questions 
	15.9.1 Checklist questions 
	1592 Problems and questions for discussion 
16 	Real Business Cycle and New Keynesian models 
	16.1 Introduction 
	16.2 The real business cycle model 
	1621 Introduction 
	16.2.2 The RBC model and business cycle facts 
	16.2.3 The model and its properties 
	16.2.4 Results 
	16.2.5 Criticisms ofthe RBC model 
	16.2.6 The impact of RBC modelling 
	16.3 The New Keynesian model and stabilization policy 
	1631 The New Keynesian Phillips curve 
	16.3.2 Stabilization bias 
	16.3.3 NK DSGE modelling 
	16.4 Conclusions 
	16.5 Questions 
	16.5.1 Checklist questions 
	16.5.2 Problems and questions for discussion 
Bibliography 
Index