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Preface
part I Introduction
Chapter 1 The Science of Macroeconomics
1-1 What Macroeconomists Study
CASE STUDY The Historical Performance of the Canadian Economy
1-2 How Economists Think
Theory as Model Building
FYI Using Functions to Express Relationships Among Variables
The Use of Multiple Models
Prices: Flexible Versus Sticky
FYI Nobel Macroeconomists
Microeconomic Thinking and Macroeconomic Models 15
1-3 How This Book Proceeds
Chapter 2 The Data of Macroeconomics
2-1 Measuring the Value of Economic Activity: Gross Domestic Product
Income, Expenditure, and the Circular Flow
Some Rules for Computing GDP
FYI Stocks and Flows
Real GDP Versus Nominal GDP
The GDP Deflator
Chain-Weighted Measures of Real GDP
The Components of Expenditure
FYI Two Arithmetic Tricks for Working with Percentage Changes
FYI What Is Investment?
CASE STUDY GDP and Its Components
Several Measures of Income
CASE STUDY Seasonal Adjustment
2-2 Measuring the Cost of Living: The Consumer Price Index
The Price of a Basket of Goods
The CPI Versus the GDP Deflator
CASE STUDY Difficulties in Measuring Inflation
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2-3 Measuring Joblessness: The Unemployment Rate
CASE STUDY Trends in Labour-Force Participation
Unemployment, GDP, and Okun’s Law
2-4 Conclusion: From Economic Statistics to Economic Models
part II Classical Theory: The Economy in the Long Run
Chapter 3 National Income: Where It Comes From and Where It Goes
3-1 What Determines the Total Production of Goods and Services?
The Factors of Production
The Production Function
The Supply of Goods and Services
3-2 How Is National Income Distributed to the Factors of Production?
Factor Prices
The Decisions Facing the Competitive Firm
The Firm’s Demand for Factors
The Division of National Income
CASE STUDY The Black Death and Factor Prices
The Cobb–Douglas Production Function
CASE STUDY Labour Productivity as the Key Determinant of Real Wages
3-3 What Determines the Demand for Goods and Services?
Consumption
Investment
FYI The Many Different Interest Rates
Government Purchases
3-4 What Brings the Supply and Demand for Goods and Services Into Equilibrium?
Equilibrium in the Market for Goods and Services: The Supply and Demand for the Economy’s Output
Equilibrium in the Financial Markets: The Supply and Demand for Loanable Funds
FYI The Growing Gap Between Rich and Poor
Changes in Saving: The Effects of Fiscal Policy
CASE STUDY Wars and Interest Rates in the United Kingdom, 1730–1920
CASE STUDY Fiscal Policy in the 1980s and 1990s
Changes in Investment Demand
3-5 Conclusion
FYI The Identification Problem
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Chapter 4 Money and Inflation
4-1 What Is Money?
The Functions of Money
The Types of Money
CASE STUDY Money in a POW Camp
The Development of Fiat Money
CASE STUDY Money and Social Conventions on the Island of Yap
How the Quantity of Money Is Controlled
How the Quantity of Money Is Measured
FYI How Do Credit Cards and Debit Cards Fit into the Monetary System?
4-2 The Quantity Theory of Money
Transactions and the Quantity Equation
From Transactions to Income
The Money Demand Function and the Quantity Equation
The Assumption of Constant Velocity
Money, Prices, and Inflation
CASE STUDY Inflation and Money Growth
4-3 Seigniorage: The Revenue from Printing Money
CASE STUDY American and Russian Inflations
4-4 Inflation and Interest Rates
Two Interest Rates: Real and Nominal
The Fisher Effect
CASE STUDY Inflation and Nominal Interest Rates
Two Real Interest Rates: Ex Ante and Ex Post
CASE STUDY Nominal Interest Rates in the Nineteenth Century
4-5 The Nominal Interest Rate and the Demand for Money
The Cost of Holding Money
Future Money and Current Prices
CASE STUDY Canadian Monetary Policy
4-6 The Social Costs of Inflation
The Layman’s View and the Classical Response
CASE STUDY What Economists and the Public Say About Inflation
The Costs of Expected Inflation
The Costs of Unexpected Inflation
CASE STUDY The Wizard of Oz
One Possible Benefit of Inflation
4-7 Hyperinflation
FYI Keynes (and Lenin) on the Cost of Inflation
The Costs of Hyperinflation
CASE STUDY Life During the Bolivian Hyperinflation
The Causes of Hyperinflation
CASE STUDY Hyperinflation in Interwar Germany
CASE STUDY Hyperinflation in Zimbabwe
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4-8 Conclusion: The Classical Dichotomy
Appendix: The Cagan Model: How Current and Future Money Affect the Price Level
Chapter 5 The Open Economy
5-1 The International Flows of Capital and Goods
The Role of Net Exports
Net Foreign Investment and the Trade Balance
International Flows of Goods and Capital: An Example
FYI The Irrelevance of Bilateral Trade Balances
5-2 Saving and Investment in a Small Open Economy
Capital Mobility and the World Interest Rate
The Model
How Policies Influence the Trade Balance
Evaluating Economic Policy
CASE STUDY The U.S. Trade Deficit
CASE STUDY Why Doesn’t Capital Flow to Poor Countries?
5-3 Exchange Rates
Nominal and Real Exchange Rates
FYI How Newspapers Report the Exchange Rate
The Real Exchange Rate and the Trade Balance
CASE STUDY Traders Respond to the Exchange Rate
The Determinants of the Real Exchange Rate
How Policies Influence the Real Exchange Rate
The Effects of Trade Policies
CASE STUDY The “Neo-Conservative” Policy Agenda in the 1980s and 1990s
The Determinants of the Nominal Exchange Rate
CASE STUDY Inflation and Nominal Exchange Rates
The Special Case of Purchasing-Power Parity
CASE STUDY The Big Mac Around the World
5-4 Large Versus Small Open Economies
Appendix: The Open Economy in the Very Long Run
Foreign Debt
Fiscal Policy
Trickle-Down Economics
Chapter 6 Unemployment
6-1 Job Loss, Job Finding, and the Natural Rate of Unemployment
6-2 Job Search and Frictional Unemployment
Public Policy and Frictional Unemployment
CASE STUDY Employment Insurance and the Rate of Job Finding
6-3 Real-Wage Rigidity and Structural Unemployment
Minimum-Wage Laws
Unions and Collective Bargaining
Efficiency Wages
CASE STUDY Henry Ford’s $5 Workday
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6-4 Labour Market Experience: Canada
The Duration of Unemployment
Variation in the Unemployment Rate Across Age Groups and Regions
Trends in Unemployment
CASE STUDY Comparing Unemployment in the United States and Canada
6-5 Labour Market Experience: Europe
The Rise in European Unemployment
Unemployment Variation Within Europe
CASE STUDY The Secrets to Happiness
The Rise of European Leisure
6-5 Conclusion
Appendix: Unemployment, Inequality, and Government Policy
Inequality
Government Policy
The Globalization Challenge
part III Growth Theory: The Economy in the Very Long Run
Chapter 7 Economic Growth I: Capital Accumulation and Population Growth
7-1 The Accumulation of Capital
The Supply and Demand for Goods
Growth in the Capital Stock and the Steady State
Approaching the Steady State: A Numerical Example
CASE STUDY The Miracle of Japanese and German Growth
How Saving Affects Growth
CASE STUDY Saving and Investment Around the World
7-2 The Golden Rule Level of Capital
Comparing Steady States
Finding the Golden Rule Steady State: A Numerical Example
The Transition to the Golden Rule Steady State
7-3 Population Growth
The Steady State with Population Growth
The Effects of Population Growth
CASE STUDYPopulation Growth Around the World
CASE STUDYThe Aging of Canada
Alternative Perspectives on Population Growth
7-4 Conclusion
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Chapter 8 Economic Growth II: Technology, Empirics, and Policy
8-1 Technological Progress in the Solow Model
The Efficiency of Labour
The Steady State with Technological Progress
The Effects of Technological Progress
8-2 From Growth Theory to Growth Empirics
Balanced Growth
Convergence
Factor Accumulation Versus Production Efficiency
CASE STUDY Is Free Trade Good for Economic Growth?
8-3 Policies to Promote Growth
Evaluating the Rate of Saving
Changing the Rate of Saving
CASE STUDY Tax Incentives for Saving and Investment
Allocating the Economy’s Investment
Establishing the Right Institutions
CASE STUDY The Colonial Origins of Modern Institutions
Encouraging Technological Progress
CASE STUDY The Worldwide Slowdown in Economic Growth: 1972–1995
8-4 Beyond the Solow Model: Endogenous Growth Theory
The Basic Model
A Two-Sector Model
The Microeconomics of Research and Development
CASE STUDY The Process of Creative Destruction
8-5 Conclusion
Appendix: Accounting for the Sources of Economic Growth
Increases in the Factors of Production
Technological Progress
The Sources of Growth in Canada
CASE STUDY Growth in the East Asian Tigers
The Solow Residual in the Short Run
part IV Business Cycle Theory: The Economy in the Short Run
Chapter 9 Introduction to Economic Fluctuations
9-1 Time Horizons in Macroeconomics
How the Short Run and the Long Run Differ
CASE STUDY If You Want to Know Why Firms Have Sticky Prices, Ask Them
The Model of Aggregate Supply and Aggregate Demand
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9-2 Aggregate Demand
The Quantity Equation as Aggregate Demand
Why the Aggregate Demand Curve Slopes Downward
Shifts in the Aggregate Demand Curve
9-3 Aggregate Supply
The Long Run: The Vertical Aggregate Supply Curve
The Short Run: The Horizontal Aggregate Supply Curve
From the Short Run to the Long Run
CASE STUDY A Monetary Lesson from French History
FYI David Hume on the Real Effects of Money
FYI The Short Run, the Long Run, and the Very Long Run
9-4 Stabilization Policy
Shocks to Aggregate Demand
Shocks to Aggregate Supply
CASE STUDY How OPEC Helped Cause Stagflation in the 1970s
9-5 Conclusion
Chapter 10 Aggregate Demand I: Building the IS–LM Model
10-1 The Goods Market and the IS Curve
The Keynesian Cross
CASE STUDY Modest Expectations Concerning Job Creation
CASE STUDY The 2009 Stimulus Package
The Interest Rate, Investment, and the IS Curve
How Fiscal Policy Shifts the IS Curve
A Loanable-Funds Interpretation of the IS Curve
10-2 The Money Market and the LM Curve
The Theory of Liquidity Preference
CASE STUDY Tight Money and Rising Interest Rates
Income, Money Demand, and the LM Curve
How Monetary Policy Shifts the LM Curve
A Quantity-Equation Interpretation of the LM Curve
10-3 Conclusion: The Short-Run Equilibrium
Chapter 11 Aggregate Demand II: Applying the IS–LM Model
11-1 Explaining Fluctuations with the IS–LM Model
How Fiscal Policy Shifts the IS Curve and Changes the Short-Run Equilibrium
How Monetary Policy Shifts the LM Curve and Changes the Short-Run Equilibrium
The Interaction Between Monetary and Fiscal Policy
CASE STUDY Policy Analysis with Macroeconometric Models
Shocks in the IS–LM Model
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FYI What Is the Bank of Canada’s Policy Instrument—the Money Supply or the Interest Rate? And What Is Quantitative Easing?
11-2 IS–LM as a Theory of Aggregate Demand
From the IS–LM Model to the Aggregate Demand Curve
The IS–LM Model in the Short Run and the Long Run
11-3 The Great Depression
The Spending Hypothesis: Shocks to the IS Curve
The Money Hypothesis: A Shock to the LM Curve
The Money Hypothesis Again: The Effects of Falling Prices
Could the Depression Happen Again?
CASE STUDY The Financial Crisis and Economic Downturn of 2008 and 2009
11-4 Conclusion
FYI The Liquidity Trap
Appendix: Aggregate Demand Theory Without the LM Curve
Aggregate Demand in a Closed Economy
Aggregate Demand in a Small Open Economy
Chapter 12 The Open Economy Revisited: The Mundell–Fleming Model and the Exchange-Rate Regime
12-1 The Mundell–Fleming Model
Components of the Model
The Model on a Y–r Graph
The Model on a Y–e Graph
12-2 The Small Open Economy Under Floating Exchange Rates
Fiscal Policy
Monetary Policy
CASE STUDY Tight Monetary Policy Combined with Loose Fiscal Policy
Trade Policy
World Interest-Rate Changes
12-3 The Small Open Economy Under Fixed Exchange Rates
How a Fixed-Exchange-Rate System Works
CASE STUDY The International Gold Standard
Fiscal Policy
Monetary Policy
CASE STUDY Devaluation and the Recovery From the Great Depression
Trade Policy
World Interest-Rate Changes
Policy in the Mundell–Fleming Model: A Summary
CASE STUDY Regional Tensions Within Canada
12-4 Interest-Rate Differentials
Country Risk and Exchange-Rate Expectations
Differentials in the Mundell–Fleming Model
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CASE STUDY International Financial Crisis: Mexico 1994–1995
CASE STUDY International Financial Crisis: Asia 1997–1998
12-5 Should Exchange Rates Be Floating or Fixed?
Pros and Cons of Different Exchange-Rate Systems
CASE STUDYMonetary Union: The Debate Over the Euro
Speculative Attacks, Currency Boards, and Dollarization
The Impossible Trinity
CASE STUDY The Chinese Currency Controversy
12-6 From the Short Run to the Long Run: The Mundell–Fleming Model with a Changing Price Level
12-7 A Concluding Reminder
Appendix: Extensions to the Mundell–Fleming Model
The Exchange Rate and the CPI
Flexible Domestic Prices
Exchange-Rate Expectations
An Attempt at Perspective
Chapter 13 Aggregate Supply and the Short-Run Tradeoff Between Inflation and Unemployment
13-1 The Basic Theory of Aggregate Supply
The Sticky-Price Model
An Alternative Theory: The Imperfect-Information Model
CASE STUDY International Differences in the Aggregate Supply Curve
Implications
13-2 Inflation, Unemployment, and the Phillips Curve
Deriving the Phillips Curve from the Aggregate Supply Curve
FYI The History of the Modern Phillips Curve
Adaptive Expectations and Inflation Inertia
Two Causes of Rising and Falling Inflation
The Short-Run Tradeoff Between Inflation and Unemployment
CASE STUDY Inflation and Unemployment in Canada
FYI How Precise Are Estimates of the Natural Rate of Unemployment?
Disinflation and the Sacrifice Ratio
Rational Expectations and the Possibility of Painless Disinflation
CASE STUDY The Sacrifice Ratio in Practice
Challenges to the Natural-Rate Hypothesis
13-3 Conclusion
Appendix: A Big, Comprehensive Model
Special Case 1: The Classic Closed Economy
Special Case 2: The Classic Small Open Economy
Special Case 3: The Basic Model of Aggregate Demand and Aggregate Supply
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Special Case 4: The IS–LM Model
Special Case 5: The Mundell–Fleming Model with a Floating Exchange Rate
Special Case 6: The Mundell–Fleming Model with a Fixed Exchange Rate
Chapter 14 A Dynamic Model of Aggregate Demand and Aggregate Supply
14-1 Elements of the Model
Output: The Demand for Goods and Services
The Real Interest Rate: The Fisher Equation
Inflation: The Phillips Curve
Expected Inflation: Adaptive Expectations
The Nominal Interest Rate: The Monetary-Policy Rule
CASE STUDY The Taylor Rule
14-2 Solving the Dynamic Model
The Long-Run Equilibrium
The Dynamic Aggregate Supply Curve
The Dynamic Aggregate Demand Curve
The Short-Run Equilibrium
14-3 Using the Model
Long-Run Growth
A Shock to Aggregate Supply
FYI The Numerical Calibration and Simulation 476
A Shock to Aggregate Demand
A Shift in Monetary Policy
14-4 Two Applications: Lessons for Monetary Policy
The Tradeoff Between Output Variability and Inflation Variability
CASE STUDY The United States Fed Versus the European Central Bank
The Taylor Principle
CASE STUDY What Caused the Great Inflation?
14-5 Conclusion: Toward DSGE Models
Appendix: Components of the Synthesis
The Theory of Real Business Cycles
The Economics of Robinson Crusoe
The Interpretation of the Labour Market
The Importance of Technology Shocks
The Neutrality of Money
CASE STUDY Testing for Monetary Neutrality
The Flexibility of Wages and Prices
New Keynesian Economics
Small Menu Costs and Aggregate-Demand Externalities
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CASE STUDY How Large are Menu Costs?
Recessions as Coordination Failure
CASE STUDY Experimental Evidence on Coordination Games
The Staggering of Wages and Prices
Conclusion
part V Macroeconomic Policy Debates
Chapter 15 Stabilization Policy
15-1 Should Policy Be Active or Passive?
Lags in the Implementation and Effects of Policies
CASE STUDY Profit Sharing as an Automatic Stabilizer
The Difficult Job of Economic Forecasting
CASE STUDY Two Episodes in Economic Forecasting
Ignorance, Expectations, and the Lucas Critique
The Historical Record
CASE STUDY Is the Stabilization of the Economy a Figment of the Data?
15-2 Should Policy Be Conducted by Rule or by Discretion?
Distrust of Policymakers and the Political Process
The Time Inconsistency of Discretionary Policy
CASE STUDY Alexander Hamilton Versus Time Inconsistency
Rules for Monetary Policy
CASE STUDY Inflation Targeting: Rule or Constrained Discretion?
CASE STUDY Central Bank Independence
CASE STUDY The Bank of Canada’s Low-Inflation Target: Implications for Fiscal Policy
15-3 Conclusion: Making Policy in an Uncertain World
Appendix: Time Inconsistency and the Tradeoff Between Inflation and Unemployment
Chapter 16 Government Debt and Budget Deficits
16-1 The Size of the Government Debt
CASE STUDY Canadian Deficits and Debt: Past, Present, and Future
16-2 Problems in Measurement
Measurement Problem 1: Inflation
Measurement Problem 2: Capital Assets
Measurement Problem 3: Uncounted Liabilities
CASE STUDY Accounting for TARP
Measurement Problem 4: The Business Cycle
Summing Up
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16-3 The Traditional View of Government Debt
FYI Taxes and Incentives
16-4 The Ricardian View of Government Debt
The Basic Logic of Ricardian Equivalence
Consumers and Future Taxes
CASE STUDY A Test of Ricardian Equivalence
CASE STUDY Why Do Parents Leave Bequests?
Making a Choice
FYI Ricardo on Ricardian Equivalence
16-5 Other Perspectives on Government Debt
Balanced Budgets Versus Optimal Fiscal Policy
Effects on Monetary Policy
Debt and the Political Process
International Dimensions
CASE STUDYThe Benefits of Indexed Bonds
16-6 Conclusion
Appendix: Estimating the Benefits of Deficit and Debt Reduction
part VI More on the Microeconomics Behind Macroeconomics
Chapter 17 Consumption
17-1 John Maynard Keynes and the Consumption Function
Keynes’s Conjectures
The Early Empirical Successes
Secular Stagnation, Simon Kuznets, and the Consumption Puzzle
17-2 Irving Fisher and Intertemporal Choice
The Intertemporal Budget Constraint
Consumer Preferences
FYI Present Value, or Why a $1,000,000 Prize Is Worth Only $623,000
Optimization
How Changes in Income Affect Consumption
How Changes in the Real Interest Rate Affect Consumption
Constraints on Borrowing
17-3 Franco Modigliani and the Life-Cycle Hypothesis
The Hypothesis
Implications
CASE STUDY The Consumption and Saving of the Elderly
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17-4 Milton Friedman and the Permanent-Income Hypothesis
The Hypothesis
Implications
CASE STUDY Income Taxes Versus Sales Taxes as an Instrument for Stabilization Policy
17-5 Robert Hall and the Random-Walk Hypothesis
The Hypothesis
Implications
CASE STUDY Do Predictable Changes in Income Lead to Predictable Changes in Consumption?
17-6 David Laibson and the Pull of Instant Gratification
The Hypothesis
Implications
CASE STUDY How to Get People to Save More
17-7 Conclusion
Chapter 18 Investment
18-1 Business Fixed Investment
The Rental Price of Capital
The Cost of Capital
The Determinants of Investment
CASE STUDY The Burden of Higher Interest Rates
Taxes and Investment
CASE STUDY Canada’s Experience with Corporate Tax Concessions
The Stock Market and Tobin’s q
CASE STUDY The Stock Market as an Economic Indicator
Alternative Views of the Stock Market: The Efficient Markets Hypothesis Versus Keynes’s Beauty Contest
Financing Constraints
Banking Crises and Credit Crunches
18-2 Residential Investment
The Stock Equilibrium and the Flow Supply
Changes in Housing Demand
FYI What Price House Can You Afford?
The Tax Treatment of Housing
18-3 Inventory Investment
Reasons for Holding Inventories
The Accelerator Model of Inventories
How the Real Interest Rate and Credit Conditions Affect Inventory Investment
18-4 Conclusion
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Chapter 19 Money Supply and Money Demand
19-1 Money Supply
100-Percent-Reserve Banking
Fractional-Reserve Banking
A Model of the Money Supply
The Instruments of Monetary Policy
CASE STUDY Bank Failures, Quantitative Easing, and Deposit Insurance
Bank Capital, Leverage, and Capital Requirements
19-2 Money Demand
Portfolio Theories of Money Demand
CASE STUDY Currency and the Underground Economy
Transactions Theories of Money Demand
The Baumol–Tobin Model of Cash Management
CASE STUDY Empirical Studies of Money Demand
Financial Innovation and the Rise of Near Money
19-3 Conclusion
Chapter 20 The Financial System: Opportunities and Dangers
20-1 What Does the Financial System Do?
Financing Investment
Sharing Risk
Dealing with Asymmetric Information
Fostering Economic Growth
CASE STUDY Microfinance: Professor Yunus’s Profound Idea
20-2 Financial Crises
The Anatomy of a Crisis
FYI The TED Spread
CASE STUDY Who Should Be Blamed for the Financial Crisis of 2008–2009?
Policy Responses to a Crisis
Policies to Prevent Crises
FYI CoCo Bonds
CASE STUDY Did Recent Practice in Macroeconomic Policy Contribute to the Financial Crisis?
CASE STUDY The European Sovereign Debt Crisis
CASE STUDY Will Governments in North America Go the Way of the Indebted European Governments?
20-3 Conclusion
Epilogue What We Know, What We Don’t
The Four Most Important Lessons of Macroeconomics
Lesson No. 1: In the long run, a country’s capacity to produce goods and services determines the standard of living of its citizens.
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Lesson No. 2: In the short run, aggregate demand influences the amount of goods and services that a country produces.
Lesson No. 3: In the long run, the rate of money growth determines the rate of inflation, but it does not affect the rate of unemployment.
Lesson No. 4: In the short run, policymakers who control monetary and fiscal policy face a tradeoff between inflation and unemployment.
The Four Most Important Unresolved Questions of Macroeconomics
Question No. 1: How should policymakers try to promote growth in the economy’s natural level of output?
Question No. 2: Should policymakers try to stabilize the economy?
Question No. 3: How costly is inflation, and how costly is reducing inflation?
Question No. 4: How big a problem are government budget deficits?
Conclusion
Glossary
Index