part 5 Preliminaries and Long-Term Fundamentals
Talking with Christina Romer 5 13
22 A First Look at Macroeconomics 517
Overheating? 518
Origins and Issues of Macroeconomics 519 Short-Term Versus Long-Term Goals 519 The Road Ahead 519
Economic Growth 520 Economic Growth in the United States 520 EconomicGrowth Around the World 523 Benefits and Costs of Economic Growth 525
Jobs and Unemployment 526 Jobs 526 Unemployment 526 Unemployment in the United States 527 UnemploymentAroundtheWorld 528 Why Unemployment Is a Problem 528
Inflation 529 Inflation in the United States 529 Inflation Around the World 530 Inflation and Interest Rates 530 Inflation and the Foreign Exchange Rate 531 Why Inflation Is a Problem 532
International Payments 533 The Current Account 533 The U.S. Current Account 533 The Capital Account 533
Macroeconomic Policy Challenges and Tools 534 Policy Challenges 534 Policy Tools 535
READING BETWEEN THE LINES The Economy in 1994 536
ECONOMICS IN HISTORY The Keynesian Revolution 542
23 Measuring GDP, Inflation, and Economic Growth 544
Economic Barometers 545
Gross Domestic Product 546 Stocks and Flows 546 The Equality of lncome, Expenditure, and the Value of Production 547 How Investment Is Financed 550
Measuring U.S. GDP 551 The Expenditure Approach 551 The Factor Incomes Approach 552 Valuing the Output of Industries 554
The Price Level and Inflation 555 The Consumer Price Index 556 The GDP Deflator 557 What the Inflation Numbers Mean 558
How Real GDP Is Used 560 International Comparisons of GDP 560 EconomicWelfare 560 Phase of the Business Cycle 563
READING BETWEEN THE LINES Diagnosing the Economy 564
24 Employment and Unemployment 570
Vital Signs 571
Employment and Wages 572 Population Survey 572 Three Labor Market Indicators 572 Aggregate Hours 574 Wage Rates 579
Unemployment and Full Employment 577 TheAnatomyofUnemployment 577 Types of Unemployment 579 Full Employment 580
Explaining Employment and Wage Rates 582 Demand and Supply in the Labor Market 582 TheTrendsinEmploymentandWageRates 583 Changes in the Distribution of jobs and Wage Rates 583
Explaining Unemployment 585 job Search 585 job Rationing 586 StickyWages 587
READING BETWEEN THE LINES Structura]ChangeatWork 588
25 Investment, Capital, and Interest 593
Building the Global Village 594
Capital and Interest 595 Investment Around the World 596 Interest Pates 596
Investment Decisions 598 The Expected Profit Rate 598 The Real Interest Rate 598 investment Demand 598 investment Demand in the United States 600
Saying and Consumption Decisions 601 Real Interest Rate 601 Disposable Income 601 Purchasing Power of Net Assets 601 Expected Future Income 602 Consumption Demand and Saying Supply 602 Disposable Income, Consumption Expenditure and Saving 604 Other Influences on Consumption Expenditure and Saving 605 Consumption Demand and Saving Supply in the United States 606
Long-Run Equilibrium in the Global Economy 608 Determining the Real Interest Rate: S = I 608 Explaining Change, in the Real Interest Rate 609 The Demand for Real GDP 6 1 0 Determining the Real Interest Rate: C + I + G = YPOT 612
Net Exports and Equilibrium in the National Economy 613 Net Exports and the Exchange Rate 614
READING BETWEEN THE LINES Interest Rates, Consumption, and Saving 616
26 Long-Term Economic Growth 621
Economic Miracles 622
Long-Term Growth Trends 623 Growth in the U.S. Economy 623 RealGDPGrowthintheWoridEconomy 624
The Sources of Economic Growth 626 Preconditions for Economic Growth 626 Saving and Investment in New Capital 626 Investment in Hurnan Capital 627 DiscoveryofNewTechnologies 627
Growth Accounting 628 The Productivity Function 628 Accounting for the Productivity Growth Slowdown and Speedup 630 Accounting for the Productivity Slowdown: A Summary 632 Technological Change During the Productivity Growth Slowdown 632
Growth Theory 633 Classical Growth Theory 634 NeoclassicalGrowthTheory 636 NewGrowthTheory 638
Achieving Faster Growth 640 The Miracle Economies 640 Policies for Faster Growth 640
READING BETWEEN THE LINES Saving and Growth 642
ECONOMICS IN HISTORY Economic Growth 648
Part 6 Macroeconomic Fluctuations and Policies
Talking with Thomas J. Sargent 650
27 Aggregate Supply and Aggregate Demand 654
Catching the Wave 655
Aggregate Supply 656 Long-Run Aggregate Supply 656 Short-Run Aggregate Supply 657 Movement Along the LAS and SAS Curves 658 ChangesinAggregateSupply 659
Aggregate Demand 661 Why the Aggregate Demand Curve Slopes Downward 662 Changes in the Quantity of Real GDP Demanded 663 Changes in Aggregate Demand 663 Expectations 663 International Factors 664 Fiscal Policy 665 Monetary Policy 665 Shifts of the Aggregate Demand Curve 666
Macroeconomic Equilibrium 667 Determination of Real GDP and the Price Level 667 Short-Run and Long-Run Macroeconomic Equilibrium 667 Long-Term Growth and Inflation 669 Fluctuations in Aggregate Demand 669 FluctuationsinAggregateSupply 671
Long-Term Growth, Inflation, and Cycles in the U.S. Economy 672 Long-Term Growth 672 Inflation 672 Cycles 673 The Evolving Economy: 1960-1994 673
READING BETWEEN THE LINES Aggregate Supply and Aggregate Demand in Action 674
28 Expenditure Multipliers 680
Economic Amplifier or Shock Absorber? 681
Sticky Prices and Expenditure Plans 682 The Aggregate Implications of Sticky Prices 682 Expenditure Plans 682 Consumption Function and Saving Function 682 Marginal Propensities to Consume and Save 684 Other Influences on Consumption Expenditure and Saving 686 The U.S. Consumption Function 686 Consumption as a Function of Real CDP 687 Import Function 688
Real GDP with a Sticky Price Level 690 Aggregate Planned Expenditure and Real GDP 691 Actual Expenditure, Planned Expenditure, and Real GDP 691 Equilibrium Expenditure 693 Convergence to Equilibrium 693
The Multiplier 694 The Basic Idea of the Multiplier 694 The Multiplier Effect 694 WhylstheMultiplierGreaterThanl? 695 The Size of the Multiplier 695 The Multiplier and the Marginal Propensity to Consume and Save 696 Imports and Income Taxes 696 Business Cycle Turning Points 697
TheMultiplier,Real GDP, and the Price Level 699 Aggregate Expenditure and Aggregate Demand 699 Aggregate Expenditure and the Price Level 699 Equilibrium GDP and the Price Level 701
READING BETWEEN THE LINES From Expansion to Recession: But When? 704
29 The Federal Budget and Fiscal Policy 709
Balancing Acts on Capitol Hill 710
The Federal Budget 711 The Institutions and Laws 711 Highlights of the 1995 Budget 712 The Budget in Historical Perspective 713 The Budget Deficit in Global Perspective 716 Budget Reform and Deficit Reduction 716 State and Local Budgets 718
Fiscal policy multipliers 718 The Government Purchases Multiplier 719 The Lump-Sum Tax Multiplier 721 The Balanced Budget Multiplier 722 Induced Taxes and Entitlement Spending 722 International Trade and Fiscal Policy Multipliers 722 Automatic Stabilizers 723
Fiscal policy in the Short Run and the Long Run 725 Fiscal Policy and Aggregate Demand 725 Fiscal Expansion at Potential GDP 727 Limitations of Fiscll policy 728 Fiscal Policy and Aggregate Supply 728 A Burden of Future Generations? 729 Crowding out 730 Ricardian Equivalence 731
READING BETWEEN THE LINES Fiscal policy in Action 732
30 Money 737
Money Makes the World Go Around 738
What Is Money? 739 Medium of Exchange 739 Unit of Account 739 Store of Value 740 Commodity Money 740 Convertible Paper Money 740 Fiat Money 741 Deposit Money 741 Money in the United States Today 742
Financial Intermediaries 744 Commercial Banks 745 Savings and Loan Associations 745 Savings Banks and Credit Unions 746 Money Market Mutual Funds 746 The Economic Functions of Financial Intermediaries 746
Financial Regulation, Deregulation, and Innovation 747 Financial Regulation 747 Deregulation in the 1980s 748 Financial Innovation 748 Deregulation, Innovation, and Money 749
How Banks Create Money 749 Reserves: Actual and Required 749 Creating Deposits by Making Loans in a One-Bank Economy 750 The Deposit Multiplier 751 Creating Deposits bY Makng Loans with Many Banks 751
Money,Real GDP, and the Price Level 753 The Short-Run Effects of a Change in the Quantity of Money 753 The Long-Run Effects of a Change in the Quantity of Money 754 The Quantity Theory of Money 755 The Quantity Theory and the AS-AD Model 756 Historical Evidence on the Quantity Theory of Money 757 International Evidence on the Quantity Theory of Money 757 Correlation, Causation, and other influences 757
READING BETWEEN THE LINES Unstable Money 760
ECONOMICS IN HISTORY Money and Inflation 762
31 The Federal Reserve and Monetary Policy 767
Temple of Secrets 768
The Federal Reserve System 769 The Origins of the Federal Reserve System 769 The Structure of the Federal Reserve SYstem 769 The Fed's Power Center 770 The Fed's Policy Tools 771 The Fed's Balance Sheet 772
Controlling the Money Supply 773 How Required Reserve Ratios Work 773 HowtheDiscountRateWorks 773 How an Open Market Operation Works 773 Monetary Base and Bank Reserves 777 The Multiplier Effect of an Open Market Operation 777
The Demand for Money 780 The Influences on Money Holding 780 The Demand for Money Curve 781 Shifts in the Demand Curve for Real Money 781 The Demand for Money in the United States 782
Interest Rate Determination 783 Money Market Equilibrium 783 Changing the Interest Rate 784
Monetary Policy 785 The Fed in Action 785 Profiting by Predicting the Fed 788 The Ripple Effects of Monetary Policy 788 Interest Rates and the Business Cycle 788
READING BETWEEN THE LINES
The Fed in Action 790
32 Inflation 795
From Rome to Russia 796
Inflation and the Price Level 797
Demand-Pull Inflation 798 Inflation Effect of an Increase in Aggregate Demand 798 Wage Response 799 A Demand-Pull Inflation Process 799
Cost-Push Inflation 800 Initial Effect of a Decrease in Aggregate Supply 800 Aggregate Demand Response 801 A Cost-Push Inflation Process 801
Anticipating Inflation 803 Unanticipated Inflation in the Labor Market 803 Unanticipated Inflation in the Capital Market 803 How People Forecast Inflation 804 Predicting People's Forecasts 804 Rational Expectation of the Price Level 804 Anticipated Inflation 806 Unanticipated Inflation 807 The Costs of Anticipated Inflation 807
Inflation and Unemployment: The Phillips Curve 809 The Short-Run Phillips Curve 809 The Long-Run Phillips Curve 81 1 Changes in the Natural Unemployment Rate 812 The Phillips Curve in the United States 812
Interest Rates and Inflation 814 The Effects of Inflation on Borrowers and Lenders 814 interest Rates and Unanticipated Inflation 814 Interest Rates and Anticipated Inflation 815 Inflation and Interest Rates in the United States 816
The Politics of Inflation 817 InflationTax 817 Errors in Forecasting the Natural Unemployment Rate 817
READING BETWEEN THE LINES
Anticipating Inflation 818
33 The Business Cycle 824
Must What Goes Up Always Come Down? 825
Cycle Patterns, Impulses, and Mechanisms 826 Business Cycle Patterns 826 Cycle Impulses and Mechanisms 826 The Central Role of Investment and Capital 827 The AS-AD Model 828
Aggregate Demand Theories of the Business Cycle 828 Keynesian Theory 828 Monetarist Theory 830 Rational Expectations Theories 832 AS-AD General Theory 834
Real Business Cycle Theory 835 The RBC Impulse 835 The RBC Mechanism 836 CriticismsofRealBusinessCycleTheory 838 DefenseofRealBusinessCycleTheory 838
Two Recent Recessions 839 The OPEC Recession 839 The 1990-1991 Recession 840 The Labor Market in the OPEC Pecession 841 The Labor Market in the 1990-1991 Recession 843
The Great Depression 844 Why the Great Depression Happened 845 Can It Happen Again? 846
READING BETWEEN THE LINES Anticipating Recession 848
ECONOMICS IN HISTORY Business Cycles 854
34 Macroeconomic Policy Challenges 856
What Can Policy Do? 857
Policy Goals 858 Potential GDP Growth 858 The Business Cycle 858 Unemployment 858 Inflation 859 The Two Core Policy Indicators: Real GDP Growth and Inflation 859
Policy Tools and Performance 860 Fiscal Policy Since 1960 860 Monetary Policy Since 1960 861
Long-Term Growth Policy 862 National Saving 862 Investment in Human Capital 864 Investment in New Technologies 864
Business Cycle and Unemployment Policy 865 Fixed-Rule Policies 865 Feedback-Rule Policies 865 Discretionary Policies 865 Stabilizing Aggregate Demand Shocks 865 Stabilizing Aggregate Supply Shocks 870 Nominal GDP Targeting 871 Natural Rate Policies 871
Inflation Policy 872 Avoiding Cost-Push Inflation 872 Slowing Inflation 873 Inflation Reduction in Practice 875 A Truly Independent Fed 875
READING BETWEEN THE LINES Stabilization Policy Dilemma 876
part 7 The Global Economy
Talking with Jacob A. Frenkel 881
35 Trading with the World 885
Silk Routes and Sucking Sounds 886
Patterns and Trends in International Trade 887 U.S. International Trade 887 Geographical Patterns 888 Trends in Trade 889 BalanceofTradeandlnternationalBorrowing 889
Opportunity Cost and Comparative Advantage 890 opportunity Cost in Farmland 890 opportunity Cost in Mobilia 891 Comparative Advantage 891
Gains from Trade 892 Reaping the Gains from Trade 892 Balanced Trade 893 Changes in Production and Consumption 893 Calculating the Gains from Trade 895 Gains for All 895 Absolute Advantage 895
Gains from Trade in Reality 896 Comparative Advantage in the Global Economy 896 Trade in Similar Goods 896
Trade Restrictions 898 The History of Tariffs 898 How Tariffs Work 899 Nontariff Barriers 901 How Quotas and VERs Work 902 "Invisible" Nontariff Barriers 903
The Case Against Protection 903 National Security 903 New Industries 904 Restraining Monopoly 904 Saves Jobs 905 Allows Us to Compete with Cheap Foreign Labor 905 Brings Diversity and Stability 906 Penalizes Lax Environmental Standards 906 Prevents Rich Countries from Exploiting Developing Countries 906 Why Is Trade Restricted? 906 Compensating Losers 907
READING BETWEEN THE LINES Free Trade in Action 908
ECONOMICS IN HISTORY Understanding the Gains from International Trade 914
36 The Balance of Payments and the Dollar 916
A Climbing Debt and a Tumbling Dollar 917
Financing International Trade 918 Balance of Payments Accounts 918 Borrowers and Lenders, Debtors and Creditors 920 Current Account Balance 921 The Ricardian Case 923 The Twin Deficits Case 923 Is U.S. Borrowing for Consumption or Investment? 924
Foreign Exchange and the Dollar 924 Foreign Exchange Systems 926 Recent Exchange Rate History 926
Exchange Rate Determination 928 The Quantity of U.S. Dollars 929 The Demand for Dollars 929 Changes in the Demand for Dollars 930 The Supply of Dollars 931 Changes in the Supply of Dollars 932 The Market for Dollars 932
READING BETWEEN THE LINES Foreign Exchange Markets in Action 936
37 Emerging Economies 942
Dramatic Economic Change 943
A Snapshot of the World Economy 944 Classification of Countries 944 Incomes Per Person 944 Income Distribution 944 Economic Growth and Decline 946
Alternative Economic Systems 947 Property Rights 947 Incentives 948 Types of Ecqnomic Systems 949 Alternative Systems Compared 950 How Capitalism Copes with Scarcity 950 How Socialism Copes with Scarcity 951
Economic Transition in Russia and Central Europe 952 History of the Soviet Union 952 Soviet-Style Central Planning 953 Living Standards in the 1980s 954 Market Economy Reforms 955 Transition Problems 955 EconomicTransitioninCentralEurope 956 East Germany 956 Czech Republic and Slovak Republic 956 Hungary 957 Poland 957
China's Emerging Market Economy 958 The Great Leap Forward 958 Deng Xiaoping's Reforms 959 China's Success 960
READING BETWEEN THE LINES Russia's Macroeconomic Performance 962
GLOSSARY 967 INDEX 978 CREDITS 1001 TABLES 1002