Fourth Edition Olivier Blanchard Massachusetts Institute of Technology PEARSON Prentice Hall Prentice Hall Upper Saddle River, New Jersey 07458
} Chapter 1 A Tour of the World 3 Chapter 2 A Tour of the Book 21 The Core 43 [Chapter 3 The Goods Market 45 [Chapter 4 Financial Markets 65 {Chapter 5 Goods and Financial Markets: The fs-lm Model 89 115 Chapter 6 The Labor Market 117 hapter 7 Putting All Markets Together: The AS-AD Model 139 apter 8 The Natural Rate of Unemployment and the Phillips Curve 165 npter 9 Inflation, Activity, and Nominal Money Growth 185 TS!! 203 10 The Facts of Growth 205 bpter 11 Saving, Capital Accumulation, and Output 223 Dter 12 Technological Progress and Growth 247 )ter 13 Technological Progress, Wages, and Unemployment 269 isions 289 289 3r 14 Expectations: The Basic Tools } 5 Financial Markets and Expectations 313 291 Chapter 16 Chapter 17 Chapter 1 8 Chapter 19 Chapter 20 Chapter 21 Expectations, Consumption, and Investment 335 Expectations, Output, and Policy 355 O«373 Openness in Goods and Financial Markets 375 The Goods Market in an Open Economy 395 Output, the Interest Rate, and the Exchange Rate 421 Exchange Rate Regimes 441 Chapter 22 Depressions and Slumps 467 Chapter 23 High Inflation 493 Back to Policy 511 Chapter 24 Should Policy Makers Be Restrained? 513 Chapter 25 Monetary Policy: A Summing Up 533 Chapter 26 Fiscal Policy: A Summing Up 553 Epilogue 575 Chapter 27 Epilogue: The Story of Macroeconomics 575 Appendix Appendix Appendix Glossary ndex 1 2 3 An Introduction to National Income and Product Accounts A-1 A Math Refresher A-6 An Introduction to Econometrics A-12 G-l -1
Preface XIV Chapter 1 A Tour of the World 3 1-1 The United States 4 Has the United States Entered a New Economy? 5 Should You Worry about the U.S. Budget Deficit? 7 1-2 The European Union 8 How Can European Unemployment Be Reduced? 10 What Will the Euro Do for Europe? 1 1 1-3 Japan 12 What Triggered the Slump? 1 3 How Chapter 4 Will Japan Recover? 15 1-4 Looking Ahead 15 Appendix: Where to Find the Numbers? 19 Chapter 2 A Tour of the Book 21 2-1 Aggregate Output 22 GDP: Production and Income 22 Nominal and Real GDP 24 2-2 The Other Major Macroeconomic Variables 28 The Unemployment Rate 28 The Inflation?Rate 31 2-3 The Short Run, the Medium Run, the Long Run 34 2-4 ATouroftheBook 35 The Core 35 Extensions 36 Back to Policy 36 Epilogue 37 Appendix: The Construction of Real GDR and Chain-Type Indexes 40 The Core 43 Chapter 5 Chapter 3 The Goods Market 45 3-1 The Composition of GDP 46 3-2 The Demand for Goods 48 Consumption (C) 48 Investment (/) 50 Government Spending (G) 50 3-3 The Determination of Equilibrium Output 50 Using Algebra 51 Using a Graph 52 Using Words 55 How Long Does It Take for Output to Adjust? 55 3-4 Investment Equals Saving: An Alternative Way of Thinking about Goods - Market Equilibrium 58 3-5 Is the Government Omnipotent? A Warning 60 Financial Markets 65 4-1 The Demand for Money 66 Deriving the Demand for Money 68 4-2 The Determination of the Interest Rate. I 69 Money Demand, Money Supply, and the Equilibrium Interest Rate 69 Monetary Policy and Open Market Operations 73 Open Market Operations 74 Choosing Money or Choosing the Interest Rate? 75 Money, Bonds, and Other Assets 76 4-3 The Determination of the Interest Rate. II 76 What Banks Do 76 The Supply and the Demand for Central Bank Money 77 4-4 Two Alternative Ways of Looking at the Equilibrium 82 The Federal Funds Market and the Federal Funds Rate 82 The Supply of Money, the Demand for Money, and the Money Multiplier 83 Goods and Financial Markets: The IS-LM Model 89 5-1 The Goods Market and the IS Relation 90 Investment, Sales, and the Interest Rate 90 Determining Output 91 Deriving the IS Curve 92 Shifts of the IS Curve 94
5-2 Financial Markets and the LM Relation 94 Real Money, Real Income, and the Interest Rate 95 Deriving the LM Curve 95 Shifts of the LM Curve 97 5-3 Putting the IS and the LM Relations Together 98 Fiscal Policy, Activity, and the Interest Rate 99 Monetary Policy, Activity, and the Interest Rate 101 5-4 Using a Policy Mix 103 5-5 How Does the IS-LMModel Fit the Facts? 107 Chapter 6 The Labor Market 117 6-1 A Tour of the Labor Market 118 The Large Flows of Workers 1 1 8 6-2 Movements in Unemployment 120 6-3 Wage Determination 124 Chapter 7 Bargaining 1 25 Efficiency Wages 1 25 Wages, Prices, and Unemployment 1 26 6-4 Price Determination 128 6-5 The Natural Rate of Unemployment 129 The Wage-Setting Relation 1 29 The Price-Setting Relation 1 29 Equilibrium Real Wages and Unemployment 1 30 From Unemployment to Employment 1 32 From Employment to Output 1 32 6-6 Where We Go From Here 133 Appendix: Wage- and Price-Setting Relations versus Labor Supply and Labor Demand 137 Putting All Markets Together: The AS-AD Model 139 7-1 Aggregate Supply 140 7-2 Aggregate Demand 142 7-3 Equilibrium in the Short Run and in the Medium Run 145 Equilibrium in the Short Run 145 From the Short Run to the Medium Run 146 7-4 The Effects of a Monetary Expansion 148 The Dynamics of Adjustment 148 Going Behind the Scenes 149 The Neutrality of Money 151 7-5 A Decrease in the Budget Deficit 151 Chapter 8 Chapter 9 Deficit Reduction, Output, and the Interest Rate 153 Budget Deficits, Output, and Investment 154 7-6 Changes in the Price of Oil 155 Effects on the Natural Rate of Unemployment 1 56 The Dynamics of Adjustment 157 7-7 Conclusions 159 The Short Run versus the Medium Run 159 Shocks and Propagation Mechanisms 160 Where We Go From Here: Output, Unemployment, and Inflation 160 The Natural Rate of Unemployment and the Phillips Curve 165 8-1 Inflation, Expected Inflation, and Unemployment 166 8-2 The Phillips Curve 167 The Early Incarnation 167 Mutations 1 68 Back to the Natural Rate of Unemployment 1 72 8-3 A Summary and Many Warnings 173 Variations in the Natural Rate Across Countries 174 Variations in the Natural Rate Over Time 1 76 High Inflation and the Phillips Curve Relation 1 76 Deflation and the Phillips Curve Relation 1 80 Appendix: From the Aggregate Supply Relation to a Relation between Inflation, Expected Inflation, and Unemployment 183 Inflation, Activity, and Nominal Money Growth 185 9-1 Output, Unemployment, and Inflation 186 Okun's Law 1 86 The Phillips Curve 1 88 The Aggregate Demand Relation 188 9-2 The Effects of Money Growth 190 The Medium Run 191 The Short Run 192 9-3 Disinflation 193 A First Pass 1 93 Expectations and Credibility: The Lucas Critique 195 Nominal Rigidities and Contracts 1 96 Chapter 10 The Facts of Growth 205 10-1 Growth in Rich Countries since 1950 206
Chapter 1 1 Chapter 1 2 The Large Increase in the Standard of Living since 1 950 208 The Decrease in Growth Rates since the Mid-1 970s 209 The Convergence of Output per Capita 209 10-2 A Broader Look across Time and Space 210 Looking across Two Millennia 211 Looking across Countries 21 1 10-3 Thinking about Growth: A Primer 213 The Aggregate Production Function 214 Returns to Scale and Returns to Factors 216 Output per Worker and Capital per Worker 217 The Sources of Growth 218 Saving, Capital Accumulation, and Output 223 11-1 Interactions between Output and Capital 224 The Effects of Capital on Output 224 The Effects of Output on Capital Accumulation 225 11-2 The Implications of Alternative Saving Rates 227 Dynamics of Capital and Output 227 Steady-State Capital and Output 229 The Saving Rate and Output 229 The Saving Rate and Consumption 232 11-3 Getting a Sense of Magnitudes 236 The Effects of the Saving Rate on Steady- State Output 237 The Dynamic Effects of an Increase in the Saving Rate 237 The U.S. Saving Rate and the Golden Rule 238 11-4 Physical versus Human Capital 240 Extending the Production Function 240 Human Capital, Physical Capital, and Output 241 Endogenous Growth 242 Appendix: The Cobb-Douglas Production Function and the Steady State 245 Technological Progress and Growth 247 12-1 Technological Progress and the Rate of Growth 248 Technological Progress and the Production Function 248 Interactions between Output and Capital 249 Dynamics of Capital and Output 252 The Effects of the Saving Rate 253 Chapter 1 3 Extensions 289 12-2 The Determinants of Technological Progress 255 The Fertility of the Research Process 255 The Appropriability of Research Results 256 12-3 The Facts of Growth Revisited 258 Capital Accumulation versus Technologica Progress 258 Fluctuations in the Pace of Technological Progress 260 12-4 Institutions and Growth 260 Appendix: Constructing a Measure of Technological Progress 267 Technological Progress, Wages, and Unemployment 269 13-1 Productivity, Output, and Unemployment in the Short Run 270 Technological Progress, Aggregate Supply, and Aggregate Demand 270 The Empirical Evidence 273 13-2 Productivity and the Natural Rate of Unemployment 274 Price Setting and Wage Setting Revisited 274 The Natural Rate of Unemployment 275 The Empirical Evidence 276 13-3 Technological Progress and Distribution Effects 279 The Increase in Wage Inequality 280 The Causes of Increased Wage Inequality 281 Chapter 14 Expectations: The Basic Tools 291 14-1 Nominal versus Real Interest Rates 292 Nominal and Real Interest Rates in the United States since 1978 294 14-2 Expected Present Discounted Values 295 Computing Expected Present Discounted Values 296 Using Present Values: Examples 297 Nominal Versus Real Interest Rates, and Present Values 299 14-3 Nominal and Real Interest Rates, and the 7S-LMModel 300 14-4 Money Growth, Inflation, Nominal and Real Interest Rates 301
Chapti ter Chapter 16 fchapter 17 Revisiting the IS-LM Model 302 Nominal and Real Interest Rates in the Short Run 303 Nominal and Real Interest Rates in the Medium Run 304 From the Short to the Medium Run 305 Evidence on the Fisher Hypothesis 306 Appendix: Deriving the Expected Present Discounted Value Using Real or Nominal Interest Rates 311 Financial Markets and Expectations 313 15-1 Bond Prices and Bond Yields 314 Bond Prices as Present Values 3 1 6 * Arbitrage and Bond Prices 3 1 6 * From Bond Prices to Bond Yields 3 1 8 * Interpreting the Yield Curve 3 1 9 * The Yield Curve and Economic Activity 31 9 15-2 The Stock Market and Movements in Stock Prices 322 Stock Prices as Present Values 323 The Stock Market and Economic Activity 324 15-3 Bubbles, Fads, and Stock Prices 326 Appendix: Arbitrage and Stock Prices 332 Expectations, Consumption, and Investment 335 16-1 Consumption 336 The Very Foresighted Consumer 337 An Example 337 Toward a More Realistic Description 338 Putting Things Together: Current Income, Expectations, and Consumption 339 16-2 Investment 341 Investment and Expectations of Profit 342 A Convenient Special Case 343 Current versus Expected Profit 346 Profit and Sales 347 16-3 The Volatility of Consumption and Investment 349 Appendix: Derivation of the Expected Present Value of Profits under Static Expectations 354 Expectations, Output, and Policy 355 17-1 Expectations and Decisions: Taking Stock 356 Expectations, Consumption, and Investment Decisions 356 Expectations and the IS Relation 356 The LM Relation Revisited 359 17-2 Monetary Policy, Expectations, and Output 360 Monetary Policy Revisited 361 Chapter 1 8 Chapter 19 17-3 Deficit Reduction, Expectations, and Output 364 The Role of Expectations about the Future 364 Back to the Current Period 365 373 Openness in Goods and Financial Markets 375 18-1 Openness in Goods Markets 376 Exports and Imports 376 The Choice between Domestic Goods and Foreign Goods 377 Nominal Exchange Rates 378 From Nominal to Real Exchange Rates 380 From Bilateral to Multilateral Exchange Rates 383 18-2 Openness in Financial Markets 384 The Balance of Payments 385 The Choice between Domestic and Foreign Assets 387 Interest Rates and Exchange Rates 389 18-3 Conclusions and a Look Ahead 392 The Goods Market in an Open Economy 395 19-1 The IS Relation in the Open Economy 396 The Demand for Domestic Goods 396 The Determinants of C, /, and G 396 The Determinants of Imports 397 The Determinants of Exports 397 Putting the Components Together 397 19-2 Equilibrium Output and the Trade Balance 399 19-3 Increases in Demand, Domestic or Foreign 400 Increases in Domestic Demand 400 Increases in Foreign Demand 402 Fiscal Policy Revisited 403 19-4 Depreciation, the Trade Balance, and Output 405 Depreciation and the Trade Balance: The Marshall-Lerner Condition 405 The Effects of a Depreciation 406 Combining Exchange-Rate and Fiscal Policies 407 19-5 Looking at Dynamics: The J-Curve 409 19-6 Saving, Investment, and the Trade Balance 413 Appendix 1: Multipliers: Belgium versus the United States 418 Appendix 2: Derivation of the Marshall- Lerner Condition 419
Chapter 20 Output, the Interest Rate, and the Exchange Rate 421 20-1 Equilibrium in the Goods Market 422 20-2 Equilibrium in Financial Markets 423 Money versus Bonds 423 Domestic Bonds versus Foreign Bonds 424 20-3 Putting Goods and Financial Markets Together 426 20-4 The Effects of Policy in an Open Economy 427 The Effects of Fiscal Policy in an Open Economy 427 The Effects of Monetary Policy in an Open Economy 429 20-5 Fixed Exchange Rates 429 Pegs, Crawling Pegs, Bands, the EMS, and the Euro 430 Pegging the Exchange Rate, and Monetary Control 432 Fiscal Policy under Fixed Exchange Rates 433 Appendix: Fixed Exchange Rates, Interest Rates, and Capital Mobility 438 Chapter 21 Exchange Rate Regimes 441 21-1 The Medium Run 442 Aggregate Demand under Fixed Exchange Rates 443 Equilibrium in the Short Run and in the Medium Run 443 The Case for and against a Devaluation 445 21-2 Exchange Rate Crises under Fixed Exchange Rates 447 21-3 Exchange Rate Movements under Flexible Exchange Rates 449 Exchange Rates and the Current Account 452 Exchange Rates, and Current and Future Interest Rates 453 Exchange Rate Volatility 453 21-4 Choosing between Exchange Rate Regimes 454 Common Currency Areas 455 Hard Pegs, Currency Boards, and Dollarization 457 Appendix 1: The Real Exchange Rate, and Domestic and Foreign Real Interest Rates 463 Appendix 2: Deriving Aggregate Demand under Fixed Exchange Rates 464 465 ~*SWSHSWSBSS»SB«Chapter 22 Depressions and Slumps 467 22-1 Disinflation, Deflation, and the Liquidity Trap 468 The Nominal Interest Rate, the Real Interest Rate, and Expected Inflation 469 The Liquidity Trap 471 Putting Things Together: The Liquidity Trap and Deflation 474 22-2 The Great Depression 475 The Initial Fall in Spending 477 The Contraction in Nominal Money 478 The Adverse Effects of Deflation 479 The Recovery 480 22-3 The Japanese Slump 481 The Rise and Fall of the Nikkei 483 The Failure of Monetary and Fiscal Policy 484 The Recovery 486 Chapter 23 High Inflation 493 23-1 Budget Deficits and Money Creation 494 23-2 Inflation and Real Money Balances 496 23-3 Deficits, Seignorage, and Inflation 499 The Case of Constant Nominal Money Growth 499 Dynamics and Increasing Inflation 501 Hyperinflation and Economic Activity 502 23-4 How Do Hyperinflations End? 503 The Elements of a Stabilization Program 503 Can Stabilization Programs Fail? 504 The Costs of Stabilization 505 23-5 Conclusions 505 Back to Policy 511 Chapter 24 Should Policy Makers Be Restrained? 513 24-1 Uncertainty and Policy 514 How Much Do Macroeconomists Actually Know? 514 Should Uncertainty Lead Policy Makers to Do Less? 5 1 6* Uncertainty and Restraints on Policy Makers 517 24-2 Expectations and Policy 518 Hostage Taking and Negotiations 518 Inflation and Unemployment Revisited 519 Establishing Credibility 520 Time Consistency and Restraints on Policy Makers 521 24-3 Politics and Policy 522 Games between Policy Makers and Voters 523 Games between Policy Makers 525 Politics and Fiscal Restraints 528
Chapter 25 Monetary Policy: A Summing Up 533 25-1 The Optimal Inflation Rate 534 The Costs of Inflation 535 The Benefits of Inflation 537 The Optimal Inflation Rate: The Current Debate 539 25-2 The Design of Monetary Policy 539 Money Growth Targets and Target Ranges 539 Money Growth and Inflation Revisited 540 Inflation Targeting 541 Interest Rate Rules 544 25-3 The Fed in Action 545 The Mandate of the Fed 545 The Organization of the Fed 546 The Instruments of Monetary Policy 546 The Implementation of Policy 548 Chapter 26 Fiscal Policy: A Summing Up 553 26-1 The Government Budget Constraint 554 The Arithmetic of Deficits and Debt 554 Current versus Future Taxes 557 The Evolution of the Debt-to-GDP Ratio 559 26-2 Four Issues in Fiscal Policy 561 Ricardian Equivalence 561 Deficits, Output Stabilization, and the Cyclically Adjusted Deficit 563 Wars and Deficits 563 The Dangers of Very High Debt 565 26-3 The U.S. Budget: Current Numbers and Future Prospects 567 Current Numbers 567 Medium-Run Budget Projections 569 The Long-Run Challenges: Low Saving, Aging, and Medical Care 570 Epilogue 575 Chapter 27 Epilogue: The Story of Macroeconomics 575 27-1 Keynesandthe Great Depression 576 27-2 The Neoclassical Synthesis 576 Progress on All Fronts 577 Keynesians versus Monetarists 578 27-3 The Rational Expectations Critique 579 Appendix Appendix 2 Appendix 3 Glossary Index 1 The Three Implications of Rational Expectations 580 The Integration of Rational Expectations 581 27-4 Current Developments 583 New Classical Economics and Real Business Cycle Theory 583 New Keynesian Economics 583 New Growth Theory 584 27-5 Common Beliefs 585 An Introduction to National Income and Product Accounts A Math Refresher A-6 An Introduction to Econometrics A-12 G-1 1-1 A-l