Macroeconomics 4th Edition by Charles I. Jones.pdf - MACROECONOMICS Fourth Edition Charles I Jones Stanford University Graduate School of Business B W W

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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 ...
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