1 Introduction and Overview of the Second Edition Chapter Overview What s New in This Second Edition... 5

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1 Contents 1 Introduction and Overview of the Second Edition Chapter Overview What s New in This Second Edition National Income Accounts Paradigm Shifts: An Introduction Some Fundamental Definitions Inflation GDP Deflator Consumer Price Index (CPI) Which Measure Does the Fed Use? Discussion Questions Budget Deficits, Trade Deficits, and Global Capital Flows: The National Savings Identity The National Savings Identity Two Crucial Assumptions Underlying the NSI Linking the Twin Deficits Possible Negative Aspects of Bond Financed Deficits Crowding Out Trade Deficits Two Cases of the NSI: The United States and China US-Type NSI China-Type NSI Factors Influencing Global Capital Flows Hot Capital: Southeast Asia, Mexico, Iceland Discussion Questions Aggregate Demand: Setting the Stage for Demand-Side Stabilization Demand-Side Stabilization Business Cycles xv

2 xvi Contents 4.3 Variables Underlying the Aggregate Demand: Introducing the Goods Market Analyzing the Components of Aggregate Demand Deriving the Aggregate Demand Discussion Questions Demand-Side Stabilization: Overheating, Hard Landing, and Everything in Between Shifting the AD: Changing Government Spending The Mechanism of the Multiplier Effect Shifting the AD: Changing Monetary Policy Shifting the AD: Tax Policy Summarizing the Three Methods of Shifting AD Unemployment Inflation Designing Macroeconomic Policy: An Exercise Demand-Pull Inflation Cost-Push Inflation The Index of Leading Economic Activity, NAPM, and Some Non-traditional Indicators Discussion Questions Long-Term Interest Rates, the Yield Curve, and Hyperinflation Expected Inflation and Long-Term Interest Rates: The Fisher Effect The Yield Curve: A Macroeconomic Perspective Negative Real Rates and SAP Bubbles Hyperinflations The Anatomy of a Meltdown Hyperinflations: Remedies Monetary Discipline: The Hazards of Pegging Discussion Questions ISLM: The Engine Room The IS Curve Some IS Exercises Introducing Taxes into the IS Curve The LM Curve Factors that Shift the LM ISLM ADAS Policy Exercises Survival Guide to ISLM ADAS Policy Analysis ISLM ADAS Policy Experiment I ISLM ADAS Policy Experiment II

3 Contents xvii ISLM ADAS Policy Exercise III An Increase in Tax Rates ISLM ADAS Policy Exercise IV: Simultaneous Increases in Government Spending and Monetary Growth ( Fine Tuning ) Summarizing IS and LM Shifts The Global IS Global IS: A Brief Overview Discussion Questions The Classical Model Classical Aggregate Supply: Derivation Derivation Sequence Policy Exercise I: Increase in G ISLM ADAS Policy Exercise II: Increase in M The Natural Rates of GDP and Employment Growth Discussion Questions The Keynesian Model Keynesian Aggregate Supply: Diagrammatic Derivation Derivation Sequence Survival Guide for ISLM with Keynesian AS (K-AS) Policy Exercise I: Increase in G Policy Exercise II: Increase in Monetary Growth Policy Exercise III: Engineering a Soft-Landing Policy Exercise IV When Low Interest Rates Don t Work Increasing M Against A Backdrop of Collapsed Confidence The Phillips Curve The Yield Curve and the Keynesian Paradigm The Agony of a Paradigm Shift: The Great Depression Mistake 1: Wage Floors Mistake 2: Tax Increases and Decreases in G Mistake 3: Liquidity Crisis Mistake 4: Smoot-Hawley Discussion Questions The Supply-Side Model and the New Economy The Expectations-Augmented AS Curve: An Explanation of the Paradigm Shift Diagrammatic Derivation: Expectations- Augmented Aggregate Supply Curve Paradigm Shift II: An Expectations-Augmented Explanation

4 xviii Contents 10.2 Supply-Side Economics Significant Income Tax Cuts Sweeping Corporate/Business Tax Cuts Deregulation Supply-Side Stabilization Stagflation From the Supply-Side to the New Economy The Identification Problem A Keynesian Explanation of the New Economy Contrasting the New Economy with the Old One Can the Two Models Be Reconciled? The Outlook for the New Economy Which Model for Developed Economies? Discussion Questions Central Banks and Monetary Policy Institutional Framework: The Federal Reserve The Money Creation Process: How the Federal Reserve Changes the Money Supply Reserve Requirements and the Money Multiplier: The Theory Open Market Operations (OMOs) Changing the Discount Rate Changing the Required Reserve Ratio The Role of the Central Bank: How Should Monetary Policy be Conducted? Milton Friedman and the Role of Monetary Policy IS Monetary Discipline Worth the Pain? The Curse of Humphrey-Hawkins The Taylor Rule Exchange Rate Pegging, Currency Crises, and Sterilization Discussion Questions Bibliography Index

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