#### You've reached the end of your free preview.

Want to read all 641 pages?

**Unformatted text preview:** MACROECONOMICS
Fourth Edition Charles I. Jones
Stanford University, Graduate School of Business B
W. W. NORTON & COMPANY
NE W YORK LONDON To Te r r y ; fo r Au d r e y a n d C h a rli e
W. W. Norton & Company has been independent since its founding in 1923, when William Warder
Norton and Mary D. Herter Norton first published lectures delivered at the People’s Institute, the adult
education division of New York City’s Cooper Union. The firm soon expanded its program beyond
the Institute, publishing books by celebrated academics from America and abroad. By mid-century,
the two major pillars of Norton’s publishing program—trade books and college texts—were firmly
established. In the 1950s, the Norton family transferred control of the company to its employees, and
today—with a staff of four hundred and a comparable number of trade, college, and professional titles
published each year—W. W. Norton & Company stands as the largest and oldest publishing house
owned wholly by its employees.
Copyright © 2018, 2014, 2011, 2010, 2008 by W. W. Norton & Company, Inc.
All rights reserved
Printed in Canada
Editor: Eric Svendsen
Editorial Assistant: Lindsey Osteen
Developmental Editor: Susan Gaustad
Managing Editor, College: Marian Johnson
Project Editor: Sujin Hong
Production Manager: Eric Pier-Hocking
Managing Editor, College Digital Media: Kim Yi
Media Project Editor: Rachel Mayer
Media Editors: Cassie del Pilar and Miryam Chandler
Associate Media Editors: Victoria Reuter and Stefani Wallace
Media Editorial Assistant: Sam Glass
Marketing Manager, Economics: Janise Turso
Art Director: Rubina Yeh
Artist: John McAusland
Designer: Lissi Sigillo
Composition: Graphic World, Inc.
Manufacturing: Transcontinental Interglobe, Inc.
ISBN: 978-0-393-60376-7
W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, NY 10110
wwnorton.com
W. W. Norton & Company Ltd., 15 Carlisle Street, London W1D 3BS
1234567890 BRIEF CONTENTS
PART 1 PRELIMINARIES
1 Introduction to Macroeconomics 4
2 Measuring the Macroeconomy 18 PART 2 THE LONG RUN
3 An Overview of Long-Run Economic Growth 44
4 A Model of Production 70
5 The Solow Growth Model 102
6 Growth and Ideas 137
7 The Labor Market, Wages, and Unemployment 175
8 Inflation 205 PART 3 THE SHORT RUN
9 An Introduction to the Short Run 234
10 The Great Recession: A First Look 255
11 The IS Curve 278
12 Monetary Policy and the Phillips Curve 309
13 Stabilization Policy and the AS/AD Framework 347
14 The Great Recession and the Short-Run Model 385
15 DSGE Models: The Frontier of Business Cycle Research 415 PART 4 APPLICATIONS AND MICROFOUNDATIONS
16 Consumption 448
17 Investment 470
18 The Government and the Macroeconomy 496
19 International Trade 520
20 Exchange Rates and International Finance 547
21 Parting Thoughts 583
iii CONTENTS Preface 2.3 Measuring Changes over Time 29 xiii Acknowledgments
About the Author xix
xxiii PART 1 PRELIMINARIES
Introduction to 1 Macroeconomics 4 1.1 What Is Macroeconomics? 5
1.2 How Macroeconomics Studies
Key Questions 9
1.3 An Overview of the Book 11
The Long Run 11
The Short Run 12
Issues for the Future 13 A Simple Example: Where Real GDP
Doesn’t Change 30
A Second Example: Where Real GDP
Changes 31
Quantity Indexes: Laspeyres, Paasche,
and Chain Weighting 32
Price Indexes and Inflation 33
Using Chain-Weighted Data 33 2.4 Comparing Economic Performance
across Countries 36
Summary 38
Key Concepts 38
Review Questions 39
Exercises 39
Worked Exercise 41 PART 2 THE LONG RUN Summary 14
Key Concepts 14
Review Questions 15
Exercises 15
Worked Exercise 17 An Overview of Long-Run 3 Economic Growth 44 3.1 Introduction 45
3.2 Growth over the Very Long Run 45 2 Measuring the
Macroeconomy 3.3 Modern Economic Growth 47
18 2.1 Introduction 19
2.2 Measuring the State of the Economy 19
Production ! Expenditure ! Income 20
The Expenditure Approach to GDP 21
The Income Approach to GDP 24
The Production Approach to GDP 26
What Is Included in GDP and What’s Not? 26 The Definition of Economic Growth 47
A Population Growth Example 49
The Rule of 70 and the Ratio Scale 50
U.S. GDP on a Ratio Scale 52
Calculating Growth Rates 53 3.4 Modern Growth around the World 54
A Broad Sample of Countries 55 3.5 Some Useful Properties of
Growth Rates 58
v vi | Contents 3.6 The Costs of Economic Growth 61 5.3 Prices and the Real Interest Rate 108 3.7 A Long-Run Roadmap 61 5.4 Solving the Solow Model 109
Using the Solow Diagram 110
Output and Consumption in the
Solow Diagram 111
Solving Mathematically for the Steady State 112 3.8 Additional Resources 62
Summary 63
Growth Rules 64
Key Concepts 64
Review Questions 64
Exercises 64
Worked Exercises 68 5.5 Looking at Data through the Lens
of the Solow Model 113
The Capital-Output Ratio 113
Differences in Y/L 114 5.6 Understanding the Steady State 115 4 A Model of Production 5.7 Economic Growth in the Solow Model 116 70 Meanwhile, Back on the Family Farm 117 4.1 Introduction 71 5.8 Some Economic Experiments 118 4.2 A Model of Production 72
Setting Up the Model 72
Allocating Resources 73
Solving the Model: General Equilibrium 76
Interpreting the Solution 78 4.3 Analyzing the Production Model 81
Comparing Models with Data 81
The Empirical Fit of the Production Model 82
Productivity Differences: Improving the
Fit of the Model 86 4.4 Understanding TFP Differences 90
Human Capital 90
Technology 91
Institutions 91
Misallocation 93 Summary 96
Key Concepts 97
Review Questions 97
Exercises 98
Worked Exercises 100 5.1 Introduction 103
5.2 Setting Up the Model 104
Production 104
Capital Accumulation 104
Labor 106
Investment 106
The Model Summarized 107 5.9 The Principle of Transition Dynamics 123
Understanding Differences in Growth Rates 124 5.10 Strengths and Weaknesses of the
Solow Model 127
Summary 128
Key Concepts 129
Review Questions 129
Exercises 129
Worked Exercises 133 6 Growth and Ideas 4.5 Evaluating the Production Model 95 5 The Solow Growth Model An Increase in the Investment Rate 118
A Rise in the Depreciation Rate 120
Experiments on Your Own 121 137 6.1 Introduction 138
6.2 The Economics of Ideas 139
Ideas
139
Nonrivalry 140
Increasing Returns 141
Problems with Pure Competition 143
102 6.3 The Romer Model 146
Solving the Romer Model 148
Why Is There Growth in the Romer Model? 150
Balanced Growth 151
Experiments in the Romer Model 152
Growth Effects versus Level Effects 154
Recapping Romer 155 6.4 Combining Solow and Romer:
Overview 156 Contents 6.5 Growth Accounting 157 8 Inflation 6.6 Concluding Our Study of
Long-Run Growth 159 8.2 The Quantity Theory of Money 209
Measures of the Money Supply 209
The Quantity Equation 211
The Classical Dichotomy, Constant Velocity,
and the Central Bank 211
The Quantity Theory for the Price Level 212
The Quantity Theory for Inflation 213
Revisiting the Classical Dichotomy 215 6.8 Additional Resources 162
Summary 162
Key Concepts 163
Review Questions 163
Exercises 164
Worked Exercises 166
APPENDIX : Combining Solow and Romer
(Algebraically) 168 Setting Up the Combined Model 168
Solving the Combined Model 168
Long-Run Growth 169
Output per Person 170
Transition Dynamics 171
More Exercises 173 The Labor Market, Wages, 7 and Unemployment 205 8.1 Introduction 206 6.7 A Postscript on Solow and Romer 161 6.9 | 175 8.3 Real and Nominal Interest Rates 216
8.4 Costs of Inflation 218
8.5 The Fiscal Causes of High Inflation 221
The Inflation Tax 221
Central Bank Independence 222 8.6 The Great Inflation of the 1970s 225
Summary 225
Key Concepts 226
Review Questions 226
Exercises 227
Worked Exercises 230 7.1 Introduction 176
7.2 The U.S. Labor Market 176
The Dynamics of the Labor Market 179 7.3 Supply and Demand 180
A Change in Labor Supply 181
A Change in Labor Demand 182
Wage Rigidity 183
Different Kinds of Unemployment 185 PART 3 THE SHORT RUN
An Introduction to the 9 Short Run 234 7.4 The Bathtub Model of Unemployment 185 9.1 Introduction 235 7.5 Labor Markets around the World 187 9.2 The Long Run, the Short Run,
and Shocks 236 Hours of Work 190 7.6 How Much Is Your Human Capital
Worth? 191
Present Discounted Value 191
Your Human Capital 192 7.7 The Rising Return to Education 193
Summary 199
Key Concepts 199
Review Questions 199
Exercises 200
Worked Exercises 202 Trends and Fluctuations 236
Short-Run Output in the United States 238
Measuring Potential Output 241
The Inflation Rate 243 9.3 The Short-Run Model 243
A Graph of the Short-Run Model 244
How the Short-Run Model Works 245
The Empirical Fit of the Phillips Curve 246
Summary 247 9.4 Okun’s Law: Output and
Unemployment 247 vii viii | Contents 9.5 Filling in the Details 250
Summary 250
Key Concepts 251
Review Questions 251
Exercises 252
Worked Exercise 254 The Great Recession: 10 A First Look 255 11.4 Using the IS Curve 285
The Basic IS Curve 285
The Effect of a Change in the Interest Rate 286
An Aggregate Demand Shock 287
A Shock to Potential Output 289
Other Experiments 290 11.5 Microfoundations of the IS Curve 290
Consumption 290
Multiplier Effects 293
Investment 294
Government Purchases 295
Net Exports 301 11.6 Conclusion 301 10.1 Introduction 256
10.2 Recent Shocks to the
Macroeconomy 257
Housing Prices 257
The Global Saving Glut 258
Subprime Lending and the Rise in
Interest Rates 259
The Financial Turmoil of 2007–2009 260
Oil Prices 263 10.3 Macroeconomic Outcomes 264
A Comparison to Previous Recessions 264
Inflation 267
The Rest of the World 269 10.4 Some Fundamentals of Financial
Economics 270
Balance Sheets 271
Leverage 272
Bank Runs and Liquidity Crises 273
Financial Wrap-Up 274 10.5 Going Forward 274 Summary 302
Key Concepts 302
Review Questions 303
Exercises 303
Worked Exercises 306 Monetary Policy and the 12 Phillips Curve 309
12.1 Introduction 310 12.2 The MP Curve: Monetary Policy
and Interest Rates 311
From Nominal to Real Interest Rates 313
The IS-MP Diagram 314
Example: The End of a Housing Bubble 315 12.3 The Phillips Curve 318
Price Shocks and the Phillips Curve 321
Cost-Push and Demand-Pull Inflation 323 12.4 Using the Short-Run Model 324 Summary 275
Key Concepts 275
Review Questions 276
Exercises 276 The Volcker Disinflation 325
The Great Inflation of the 1970s 327
The Short-Run Model in a Nutshell 329 12.5 Microfoundations: Understanding
Sticky Inflation 330
The Classical Dichotomy in the Short Run 330 11 The IS Curve 278 11.1 Introduction 279
11.2 Setting Up the Economy 280
Consumption and Friends 281
The Investment Equation 281 11.3 Deriving the IS Curve 283 12.6 Microfoundations: How Central Banks
Control Nominal Interest Rates 333
Changing the Interest Rate 335
Why it instead of Mt? 335 12.7 Inside the Federal Reserve 338
Conventional Monetary Policy 338
Open-Market Operations: How the Fed
Controls the Money Supply 339 Contents 12.8 Conclusion 340 The Great Recession and 14 the Short-Run Model Summary 340
Key Concepts 341
Review Questions 341
Exercises 342
Worked Exercises 344 14.1 Introduction 386
14.2 Financial Considerations in the
Short-Run Model 387
Financial Frictions 387
Financial Frictions in the
IS/MP Framework 388
Financial Frictions in the
AS/AD Framework 390
The Dangers of Deflation 392 Stabilization Policy and the 13 AS/AD Framework 347 13.1 Introduction 348
13.2 Monetary Policy Rules and
Aggregate Demand 349 14.3 Policy Responses to the
Financial Crisis 395
The Taylor Rule and Monetary
Policy 395
The Money Supply 397
The Fed’s Balance Sheet 398
The Troubled Asset Relief Program 402
Fiscal Stimulus 403
The European Debt Crisis 403
Financial Reform 403 The AD Curve 350
Moving along the AD Curve 351
Shifts of the AD Curve 352 13.3 The Aggregate Supply Curve 352
13.4 The AS/AD Framework 353
The Steady State 354
The AS/AD Graph 354 13.5 Macroeconomic Events in the
AS/AD Framework 355
Event #1: An Inflation Shock 355
Event #2: Disinflation 359
Event #3: A Positive AD Shock 361
Further Thoughts on Aggregate
Demand Shocks 364 14.4 The Aftermath of the
Great Recession 406
Secular Stagnation 406
A Productivity Slowdown? 406 14.5 Conclusion 408
Summary 409
Key Concepts 410
Review Questions 410
Exercises 411
Worked Exercise 413 13.6 Empirical Evidence 365
Predicting the Fed Funds Rate 365
Inflation-Output Loops 366 13.7 Modern Monetary Policy 369
More Sophisticated Monetary
Policy Rules 371
Rules versus Discretion 371
The Paradox of Policy and
Rational Expectations 372
Managing Expectations in the
AS/AD Model 373
Inflation Targeting 375 13.8 Conclusion 376
Summary 377
Key Concepts 378
Review Questions 378
Exercises 379
Worked Exercises 382 385 15 DSGE Models: The
Frontier of Business
Cycle Research 415 15.1 Introduction 416
15.2 A Brief History of DSGE Models 417
From Real Business Cycles
418
to DSGE
Endogenous Variables 419
Shocks 419
Features 419
Mathematics and DSGE Models 420 | ix x | Contents 15.3 A Stylized Approach to DSGE 421
Labor Demand 421
Labor Supply 422
Equilibrium in the Labor Market 423 15.4 Using the Stylized DSGE Model 424
A Negative TFP Shock 424
A Rise in Taxes Paid by Firms 425
A Rise in Government Purchases 426
Introducing Monetary Policy and
Unemployment: Sticky Wages 428
Monetary Policy and Sticky Prices 430
Lessons from the Labor Market in
DSGE Models 431 15.5 Quantitative DSGE Models 431
Impulse Response Functions 432
A Total Factor Productivity Shock 434
A Shock to Government Purchases 436
A Financial Friction Shock 437 15.6 Conclusion 438
Summary 438
Key Concepts 439
Review Questions 439
Exercises 440
Worked Exercise 442 15.7 APPENDIX : Deriving the Labor Supply Curve 444 PART 4 APPLICATIONS AND MICROFOUNDATIONS 16 Consumption 448 16.1 Introduction 449
16.2 The Neoclassical Consumption
Model 449
The Intertemporal Budget Constraint 449
Utility 450
Choosing Consumption to Maximize
Utility 451
Solving the Euler Equation: Log Utility 453
Solving for c today and c future: Log Utility
and ! ! 1 454
The Effect of a Rise in R on Consumption 455 16.3 Lessons from the Neoclassical Model 455
The Permanent-Income Hypothesis 455
Ricardian Equivalence 457 Borrowing Constraints 457
Consumption as a Random Walk 458
Precautionary Saving 459 16.4 Empirical Evidence on Consumption 460
Evidence from Individual Households 460
Aggregate Evidence 462
Summary 465
Key Concepts 466
Review Questions 466
Exercises 466
Worked Exercise 469 17 Investment 470 17.1 Introduction 471
17.2 How Do Firms Make Investment
Decisions? 472
Reasoning with an Arbitrage Equation 472
The User Cost of Capital 473
Example: Investment and the
Corporate Income Tax 474
From Desired Capital to Investment 478 17.3 The Stock Market and Financial
Investment 479
The Arbitrage Equation and the
Price of a Stock 480
P/E Ratios and Bubbles? 482
Efficient Markets 483 17.4 Components of Private Investment 486
Residential Investment 487
Inventory Investment 488
Summary 490
Key Concepts 491
Review Questions 491
Exercises 491
Worked Exercises 494 The Government and the 18 Macroeconomy 496 18.1 Introduction 497
18.2 U.S. Government Spending
and Revenue 497
Spending and Revenue over Time 498
The Debt-GDP Ratio 499 Contents 18.3 International Evidence on Spending
and Debt 501 | Exercises 543
Worked Exercise 545 18.4 The Government Budget Constraint 502
The Intertemporal Budget Constraint 503 18.5 How Much Can the Government
Borrow? 505
Economic Growth and the
Debt-GDP Ratio 505
High Inflation and Default 506
Generational Accounting 507
Deficits and Investment 507 Exchange Rates and 20 International Finance 547 20.1 Introduction 548
20.2 Exchange Rates in the Long Run 548
The Nominal Exchange Rate 548
The Law of One Price 549
The Real Exchange Rate 552
Summary 553 18.6 The Fiscal Problem of the
Twenty-First Century 509 20.3 Exchange Rates in the Short Run 555 The Problem 510
Possible Solutions 513 The Nominal Exchange Rate 555
The Real Exchange Rate 556 18.7 Conclusion 515 20.4 Fixed Exchange Rates 557
Summary 516
Key Concepts 516
Review Questions 516
Exercises 517
Worked Exercise 518 19 International Trade 20.5 The Open Economy in the
Short-Run Model 558
The New IS Curve 559
Event #1: Tightening Domestic Monetary
Policy and the IS Curve 560
Event #2: A Change in Foreign
Interest Rates 561
520 19.1 Introduction 521
19.2 Some Basic Facts about Trade 522
19.3 A Basic Reason for Trade 524
19.4 Trade across Time 525
19.5 Trade with Production 527
Autarky 528
Free Trade 530
Lessons from the Apple: Computer
Example 531 19.6 Trade in Inputs 532
Moving Capital versus Moving Labor 533 20.6 Exchange Rate Regimes 562
20.7 The Policy Trilemma 564
Which Side of the Triangle to Choose? 567
The Future of Exchange Rate Regimes 570 20.8 The Euro Crisis 572
The Crisis of 2011–2013 575
Long-Term Competitiveness 576
Summary 577
Key Concepts 578
Review Questions 579
Exercises 579
Worked Exercises 581 19.7 The Costs of Trade 534
19.8 The Trade Deficit and Foreign Debt 537
Trade and Growth around the World 537
The Twin Deficits 538
Net Foreign Assets and Foreign Debt 540 19.9 Conclusion 541
Summary 542
Key Concepts 543
Review Questions 543 21 Parting Thoughts 583 21.1 What We’ve Learned 584
21.2 Significant Remaining Questions 586
21.3 Conclusion 589
Glossary 590
Index 605 xi Contents | xiii PREFACE TO THE FOURTH EDITION T he macroeconomic events of the last decade
are truly breathtaking—a once-in-a-lifetime
(we hope) occurrence. While the basics of
how economists understand the macroeconomy
remain solid, the global financial crisis and the
Great Recession take us into waters that, if not uncharted, at least have not been visited in more than
half a century. The recovery of the U.S., European,
and world economies from these shocks has been
remarkably subdued. And, perhaps most troubling
of all, the productivity growth that underlies longrun economic performance has been surprisingly
slow for more than a decade.
This new edition continues the tradition established in previous versions: providing up-to-date,
modern analysis of both current events and classic
issues in macroeconomics. For example, new measures of standards of living (Chapter 2), China’s
impact on U.S. jobs and wage inequality (Chapter 7),
the latest research on the Great Recession (Chapters 10 and 14), and the Euro-area financial crisis
(Chapter 20) are all incorporated. A new primer in
Chapter 12 helps students to bridge the gap between the old IS-LM model and the new IS-MP
model, which is rapidly displacing the IS-LM
framework as a guide to the short run. A new exercise in virtually every chapter asks students to
obtain and analyze up-to-date data from the Federal Reserve’s FRED database. This fourth edition
also incorporates many new case studies and exercises, extensive updates to tables and figures to
reflect the most current data, and improvements on
nearly every page in the text.
It is a fascinating time to study macroeconomics,
and I look forward to sharing astounding facts about
the macroeconomy with you and to discussing the
Nobel-caliber ideas that help us understand them. Innovations
(This section will make the most sense to students
with some familiarity with macroeconomics and
instructors. Students new to the subject may skip
to the Guided Tour.)
Most other books for teaching intermediate macroeconomics were first written more than twenty
years ago. Our understanding of the macroeconomy
has improved substantially since then. This book
provides an accessible and yet modern treatment. Its
order and structure will feel familiar to instructors,
but the execution, examples, and pedagogy have
been updated to incorporate the best that macroeconomics instruction has to offer.
What’s special about this book? Innovations
occur throughout, but the key ones are described
below.
Two Chapters on the Great Recession
The global financial crisis and the Great Recession
that followed are obviously the most important
macroeconomic events in decades. While these
events are discussed throughout in sections devoted to the short run, two chapters explicitly focus
on recent events. Chapter 10 (The Great Recession:
A First Look) immediately follows the first introductory chapter on the short run, exposing students to the facts of the last several years and to
critical ...

View
Full Document