1. Let’s consider some more special cases of the mother of all models. Starting with this comprehensive model, what extra assumptions would you need to yield each of the following specialized models?
The model of the classical large open economy in the appendix to Chapter 6.
The Keynesian cross in the first half of Chapter 11.
The IS–LM model for the large open economy in the appendix to Chapter 13.
1 Mathematical note: The firm cares most about its relative price, which is the ratio of its nominal price to the overall price level. If we interpret p and P as the logarithms of the firm’s price and the price level, then this equation states that the desired relative price depends on the deviation of output from its natural level.
2 For a more advanced development of the sticky-price model, see Julio Rotemberg, “Monopolistic Price Adjustment and Aggregate Output,” Review of Economic Studies 49 (1982): 517–531; and Guillermo Calvo, “Staggered Prices in a Utility-Maximizing Framework,” Journal of Monetary Economics 12, no. 3 (1983): 383–398.
3 To read Lucas’s description of his model, see Robert E. Lucas, Jr., “Understanding Business Cycles,” Stabilization of the Domestic and International Economy, vol. 5 of the Carnegie-Rochester Conference on Public Policy (Amsterdam: North-Holland, 1977), 7–29. Lucas was building on the work of Milton Friedman, another Nobel Prize winner. See Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58 (March 1968): 1–17. For the recent work emphasizing the role of information-processing constraints, see Michael Woodford, “Imperfect Common Knowledge and the Effects of Monetary Policy,” in P. Aghion, R. Frydman, J. Stiglitz, and M. Woodford, eds., Knowledge, Information, and Expectations in Modern Macroeconomics: In Honor of Edmund S. Phelps (Princeton, NJ: Princeton University Press, 2002); and N. Gregory Mankiw and Ricardo Reis, “Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve,” Quarterly Journal of Economics 117 (November 2002): 1295–1328.
4 Robert E. Lucas, Jr., “Some International Evidence on Output-Inflation Tradeoffs,” American Economic Review 63 (June 1973): 326–334.
5 Laurence Ball, N. Gregory Mankiw, and David Romer, “The New Keynesian Economics and the Output-Inflation Tradeoff,” Brookings Papers on Economic Activity 1988, no. 1: 1–65.
6 Mathematical note: This statement is not precise because inflation is really the percentage change in the price level. To make the statement more precise, interpret P as the logarithm of the price level. By the properties of logarithms, the change in P is roughly the inflation rate. The reason is that dP = d(log price level) = d(price level)/price level.
7 A. W. Phillips, “The Relationship Between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861–1957,” Economica 25 (November 1958): 283–299.
8 For a study of inflation during the deep recession of 2008–2009, see Laurence Ball and Sandep Mazumder, “Inflation Dynamics and the Great Recession,” Brookings Papers on Economic Activity, 2011, no. 2: 337–405.
9 Douglas Staiger, James H. Stock, and Mark W. Watson, “How Precise Are Estimates of the Natural Rate of Unemployment?” in Christina D. Romer and David H. Romer, eds., Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press, 1997), 195–246; Dave Reifschneider, William Wascher, and David Wilcox, “Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy,” Federal Reserve Working Paper, 2013.
10 Two classic studies of the sacrifice ratio are Arthur M. Okun, “Efficient Disinflationary Policies,” American Economic Review 68 (May 1978): 348–352; and Robert J. Gordon and Stephen R. King, “The Output Cost of Disinflation in Traditional and Vector Autoregressive Models,” Brookings Papers on Economic Activity 1982, no. 1: 205–245.
11 Thomas J. Sargent, “The Ends of Four Big Inflations,” in Robert E. Hall, ed., Inflation: Causes and Effects (Chicago: University of Chicago Press, 1982), 41–98.
12 Laurence Ball, “What Determines the Sacrifice Ratio?” in N. Gregory Mankiw, ed., Monetary Policy (Chicago: University of Chicago Press, 1994), 155–193.
13 Olivier J. Blanchard and Lawrence H. Summers, “Beyond the Natural Rate Hypothesis,” American Economic Review 78 (May 1988): 182–187; Laurence Ball, “Disinflation and the NAIRU,” in Christina D. Romer and David H. Romer, eds., Reducing Inflation: Motivation and Strategy (Chicago: University of Chicago Press, 1997), 167–185; Laurence Ball, “Long-Term Damage from the Great Recession in OECD Countries,” NBER Working Paper No. 20185, 2014.