Macroeconomics...Chapter 27 Epilogue: The Story of Macroeconomics 579 Chapter 28 The Global Crisis 593

MacroeconomicsFifth Edition

UPDATED EDITION

Olivier BlanchardMassachusetts Institute of Technology

Boston Columbus Indianapolis New York San Francisco Upper Saddle RiverAmsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

Brief Contents

The Core Extensions

Chapter 1 A Tour of the World 3Chapter 2 A Tour of the Book 19

« • •

u. 4 1Chapter 3 The Goods Market 43Chapter 4 Financial Markets 63Chapter 5 Goods and Financial Markets:

The/S-LM Model 85

111Chapter 6 The Labor Market 113Chapter 7 Putting All Markets Together:

The AS-AD Model 135Chapter 8 The Natural Rate of

Unemployment and thePhillips Curve 163

Chapter 9 Inflation, Activity, and NominalMoney Growth 183

ona Run 2 0 3Chapter 10 The Facts of Growth 205Chapter 1 1 Saving, Capital Accumulation,

and Output 223Chapter 1 2 Technological Progress and

Growth 247Chapter 1 3 Technological Progress: The

Short, the Medium, and theLong Run 267

2 8 9Chapter 14 Expectations: The Basic

Tools 291Chapter 1 5 Financial Markets and

Expectations 313Chapter 16 Expectations, Consumption,

and Investment 335Chapter 1 7 Expectations, Output,

and Policy 357

375Chapter 1 8 Openness in Goods and Financial

Markets 377Chapter 19 The Goods Market in an Open

Economy 397Chapter 20 Output, the Interest Rate, and

the Exchange Rate 421Chapter 21 Exchange Rate Regimes 441

4 6 7Chapter 22 Depressions and Slumps 469Chapter 23 High Inflation 495

5 1 3Chapter 24 Should Policymakers Be

Restrained? 515Chapter 25 Monetary Policy: A

Summing Up 535Chapter 26 Fiscal Policy: A Summing Up 555Chapter 27 Epilogue: The Story of

Macroeconomics 579Chapter 28 The Global Crisis 593

Content:

The Core

i n nT M\ i FTIChapter 1

Chapter 2

A Tour of the World 31-1 The United States 4

Has the United States Entered a NewEconomy 5 • Should We Worry About5 •the U.S. Trade Deficit? 7

1-2 The European Union 8How Can European Unemployment BeReduced? 10 • What Will the Euro Dofor Europe? 1 2

1-3 China 121-4 Looking Ahead 14Appendix: Where to Find theNumbers? 18A Tour of the Book 192-1 Aggregate Output 20

GDP: Production and Income 20 •Nominal and Real GDP 22 • GDP:Level versus Growth Rate 24

2-2 The Other Major MacroeconomicVariables 26The Unemployment Rate 26 • TheInflation Rate 28 • The GDPDeflator 28 • The Consumer PriceIndex 30

2-3 The Short Run, the Medium Run,and the Long Run 32

2-4 A Tour of the Book 33The Core 33 • Extensions 35 •Back to Policy 35 • Epilogue 35

Appendix: The Construction of RealGDP and Chain-Type Indexes 39

Chapter 3 The Goods Market 433-1 The Composition of GDP 443-2 The Demand for Goods 45

Consumpton (C] 46 • Investment(/) 48 • Government Spending (G) 48

3-3 The Determination of EquilibriumOutput 49Using Algebra 50 • Using a Graph51 • Using Words 53 • HowLong Does It Take for Output toAdjust? 54

3-4 Investment Equals Saving: AnAlternative Way of Thinkingabout Goods-MarketEquilibrium 56

3-5 Is the Government Omnipotent?A Warning 58

Chapter 4 Financial Markets 634-1 The Demand for Money 64

Deriving the Demand for Money 664-2 Determining the Interest

Rate, I 68Money Demand, Money Supply, and theEquilibrium Interest Rate 68 • MonetaryPolicy and Open Market Operations 70• Bond Prices and Bond Yields 71• Choosing Money or Choosing theInterest Rate? 72 • Money, Bonds,and Other Assets 72

4-3 The Determination of InterestRate, II* 73What Banks Do 73 • The Supply andthe Demand for Central BankMoney 74 • The Demand forMoney 76 • The Demand forReserves 76 • The Demand for CentralBank Money 77 • The Determinationof the Interest Rate 77

4-4 Two Alternative Ways of Looking atthe Equilibrium* 79The Federal Funds Market and the FederalFunds Rate 79 • The Supply of Money,the Demand for Money, and the MoneyMultiplier 79 • Understanding theMoney Multiplier 80

Chapter 5 Goods and Financial Markets: The/S-LM Model 855-1 The Goods Market and the IS

Relation 86Investment, Sales, and the InterestRate 86 • Determining Output 87 •Deriving the IS Curve 88 • Shifts of theIS Curve 88

5-2 Financial Markets and the LMRelation 90Real Money, Real Income, and the InterestRate 90 • Deriving the LA/1 Curve 91• Shifts of the IM Curve 92

5-3 Putting the IS and the LMRelations Together 93Fiscal Policy, Activity, and the InterestRate 94 • Monetary Policy, Activity,and the Interest Rate 96

5-4 Using a Policy Mix 985-5 How Does the IS-LMModel Fit the

Facts? 102Appendix: An Alternative Derivation ofthe LM Relation as an Interest RateRule? 108

1 1 1

Chapter 6 The Labor Market 1136-1 A Tour of the Labor Market 114

The Large Flows of Workers 1 14

6-2 Movements in

Unemployment 1166-3 Wage Determination 120

Bargaining 121 • EfficiencyWages 121 • Wages, Prices, andUnemployment 122

6-4 Price Determination 1246-5 The Natural Rate of

Unemployment 125The Wage-Setting Relation 1 25 • ThePrice-Setting Relation 1 25 • EquilibriumReal Wages and Unemployment 1 26 •From Unemployment to Employment 1 28• From Employment to Output 1 29

6-6 Where We Go from Here 129Appendix: Wage and Price SettingRelations versus Labor Supply andLabor Demand 133

Chapter 7 Putting All Markets Together:The AS-AD Model 1357-1 Aggregate Supply 136

7-2 Aggregate Demand 1387-3 Equilibrium in the Short Run and

in the Medium Run 141Equilibrium in the Short Run 141 • Fromthe Short Run to the Medium Run 142

7-4 The Effects of a MonetaryExpansion 144The Dynamics of Adjustment 144 •Going Behind the Scenes 145 •The Neutrality of Money 147

7-5 A Decrease in the BudgetDeficit 147Deficit Reduction, Output, and the InterestRate 149 • Budget Deficits, Output, andInvestment 150

7-6 Changes in the Price of Oil 151Effects on the Natural Rate ofUnemployment 153 • The Dynamics ofAdjustment 153

7-7 Conclusions 157The Short Run versus the Medium Run 157• Shocks and Propagation Mechanisms158 • Where We Go from Here:Output, Unemployment, and Inflation 158

Chapter 8 The Natural Rate ofUnemployment and the PhillipsCurve 1638-1 Inflation, Expected Inflation, and

Unemployment 1648-2 The Phillips Curve 165

The Early Incarnation 165 • Mutations166 • Back to the Natural Rate ofUnemployment 170

8-3 A Summary and ManyWarnings 171Variations in the Natural Rate AcrossCountries 1 72 • Variations in theNatural Rate over Time 174 • HighInflation and the Phillips Curve Relation177 • Deflation and the PhillipsCurve Relation 178

Appendix: From the Aggregate SupplyRelation to a Relation betweenInflation, Expected Inflation, andUnemployment 181

Chapter 9 Inflation, Activity, and NominalMoney Growth 1839-1 Output, Unemployment, and

Inflation 184Okun's Law 1 84 • The Phillips

Curve 1 86 • The Aggregate

Demand Relation 1 86

Contents

9-2 The Effects of Money Growth 188The Medium Run 1 89 • The ShortRun 190

9-3 Disinflation 191A First Pass 191 • Expectations andCredibility: The Lucas Critique 193 •Nominal Rigidities and Contracts 194

2 0 3

Chapter 10 The Facts of Growth 20510-1 Measuring the Standard of

Living 20610-2 Growth in Rich Countries since

1950 210The Large Increase in the Standard ofLiving since 1950 21 1 • TheConvergence of Output per PersonSince 1950 211

10-3 A Broader Look at Growth acrossTime and Space 213Looking at Growth across TwoMillennia 213 • Looking at Growthacross Many Countries 21 3

10-4 Thinking About Growth: APrimer 215The Aggregate ProductionFunction 215 • Returns to Scale andReturns to Factors 2 1 6 * Output perWorker and Capital per Worker 21 7• The Sources of Growth 21 7

Chapter 1 1 Saving, Capital Accumulation,and Output 22311-1 Interactions Between Output

and Capital 224The Effects of Capital on Output 224• The Effects of Output on CapitalAccumulation 225

11-2 The Implications of AlternativeSaving Rates 227Dynamics of Capital and Output 227 •Steady-State Capital and Output 229 •The Saving Rate and Output 230 •The Saving Rate and Consumption 232

11-3 Getting a Sense ofMagnitudes 236The Effects of the Saving Rate on Steady-State Output 236 • The Dynamic Effectsof an Increase in the Saving Rate 237• The U.S. Saving Rate and the GoldenRule 239

11-4 Physical versus HumanCapital 240

Extending the Production Function 240• Human Capital, Physical Capital,and Output 241 • EndogenousGrowth 242

Appendix: The Cobb-DouglasProduction Function and the SteadyState 245

Chapter 1 2 Technological Progress andGrowth 24712-1 Technological Progress and the

Rate of Growth 248Technological Progress and the ProductionFunction 248 • Interactions betweenOutput and Capital 249 • Dynamics ofCapital and Output 252 • The Effectsof the Saving Rate 253

12-2 The Determinants ofTechnological Progress 255The Fertility of the Research Process 255• The Appropriabilily of ResearchResults 258

12-3 The Facts of GrowthRevisited 260Capital Accumulation versus TechnologicalProgress in Rich Countries since 1950263 • Capital Accumulation versusTechnological Progress in China since1980 261

Appendix: Constructing a Measure ofTechnological Progress 265

Chapter 1 3 Technological Progress: The Short,the Medium, and the LongRun 26713-1 Productivity, Output, and

Unemployment in the ShortRun 268Technological Progress, AggregateSupply, and Aggregate Demand 268• The Empirical Evidence 270

13-2 Productivity and the Natural Rateof Unemployment 271Price Setting and Wage SettingRevisited 272 • The Natural Rate ofUnemployment 273 • The EmpiricalEvidence 274

13-3 Technological Progress, Churning,and Distribution Effects 276The Increase in Wage Inequality 279• The Causes of Increased WageInequality 279

13-4 Institutions, TechnologicalProgress, and Growth 282

Contents

Extensions289

Chapter 14 Expectations: The BasicTools 29114-1 Nominal versus Real Interest

Rates 292Nominal and Real Interest Rates in theUnited States since 1978 294

14-2 Nominal and Real Interest Rates,and the IS-LM Model 295

14-3 Money Growth, Inflation, andNominal and Real InterestRates 296Revisiting the IS-IM Model 297• Nominal and Real Interest Rates in theShort Run 298 • Nominal and RealInterest Rates in the Medium Run 299• From the Short Run to the MediumRun 300 • Evidence on the FisherHypothesis 301

14-4 Expected Present DiscountedValues 304Computing Expected Present DiscountedValues 304 • The General Formula305 • Using Present Values: Examples306 • Constant Interest Rates 306 •Constant Interest Rates and Payments306 • Constant Interest Rates andPayments Forever 307 • Zero InterestRates 307 • Nominal versus RealInterest Rates and Present Values 307

Appendix: Deriving the ExpectedPresent Discounted Value Using Real orNominal Interest Rates 310

Chapter 1 5 Financial Markets andExpectations 31315-1 Bond Prices and Bond Yields 314

B o n d Prices as Present Values 3 1 6 *A r b i t r a g e a n d B o n d Prices 3 1 6 *From B o n d Prices to B o n d Y ie lds 3 1 8 *In terpre t ing the Y i e l d C u r v e 3 1 9 * TheY i e l d C u r v e a n d E c o n o m i c Ac t i v i t y 3 1 9

15-2 The Stock Market and Movementsin Stock Prices 322Stock Prices as Present Values 323 •The Stock Market and Economic Activity324 • A Monetary Expansion and theStock Market 324 • An Increase inConsumer Spending and the StockMarket 325

15-3 Bubbles, Fads, and StockPrices 326

Appendix: Arbitrage and StockPrices 332

Chapter 16 Expectations, Consumption, andInvestment 33516-1 Consumption 336

The Very Foresighted Consumer337 • An Example 337 • Toward aMore Realistic Description 338• Putting Things Together: Current Income,Expectations, and Consumption 340

16-2 Investment 342Investment and Expectations ofProfit 342 • Depreciation 343 •The Present Value of Expected Profits343 • The Investment Decision 344• A Convenient Special Case 344• Current versus Expected Profit 347• Profit and Sales 349

16-3 The Volatility of Consumption andInvestment 350

Appendix: Derivation of the ExpectedPresent Value of Profits Under StaticExpectations 355

Chapter 17 Expectations, Output, andPolicy 35717-1 Expectations and Decisions:Taking Stock 358

Expectations, Consumption, and InvestmentDecisions 358 • Expectations and theIS Relation 358 • The LM RelationRevisited 361

17-2 Monetary Policy, Expectations,and Output 362From the Short Nominal Rate to Currentand Expected Real Rates 362• Monetary Policy Revisited 363

17-3 Deficit Reduction, Expectations,and Output 366The Role of Expectations about theFuture 366 • Back to the CurrentPeriod 367

375Chapter 1 8 Openness in Goods and

Financial Markets 37718-1 Openness in Goods Markets 378

Exports and Imports 378 • The ChoiceBetween Domestic Goods and ForeignGoods 379 • Nominal ExchangeRates 380 • From Nominal to RealExchange Rates 382 • From Bilateralto Multilateral Exchange Rates 385

Contents

18-2 Openness in FinancialMarkets 386The Balance of Payments 387 • TheChoice between Domestic and ForeignAssets 388 • Interest Rates andExchange Rates 391

18-3 Conclusions and a LookAhead 393

Chapter 19 The Goods Market in anOpen Economy 39719-1 The IS Relation in an OpenEconomy 398

The Demand for Domestic Goods 398• The Determinants of C, /, and G398 • The Determinants of Imports399 • The Determinants of Exports 399• Putting the Components Together 399

19-2 Equilibrium Output and the TradeBalance 401

19-3 Increases in Demand, Domestic orForeign 402Increases in Domestic Demand 402• Increases in Foreign Demand 404• Fiscal Policy Revisited 405

19-4 Depreciation, the Trade Balance,and Output 407

Depreciation and the Trade Balance:The Marshall-Lerner Condition 407• The Effects of a Depreciation 408• Combining Exchange Rate and FiscalPolicies 408

19-5 Looking at Dynamics: TheJ-Curve 410

19-6 Saving, Investment, and the TradeBalance 412

Appendix: Derivation of the Marshall-Lerner Condition 418

Chapter 20 Output, the Interest Rate, and theExchange Rate 42120-1 Equilibrium in the Goods

Market 42220-2 Equilibrium in Financial

Markets 423Money versus Bonds 423 • DomesticBonds versus Foreign Bonds 424

20-3 Putting Together Goods andFinancial Markets 426

20-4 The Effects of Policy in an OpenEconomy 428The Effects of Fiscal Policy in an OpenEconomy 428 • The Effects of

Monetary Policy in an OpenEconomy 429

20-5 Fixed Exchange Rates 430Pegs, Crawling Pegs, Bands, the EMS,and the Euro 430 • Pegging theExchange Rate and MonetaryControl 431 • Fiscal Policy underFixed Exchange Rates 434

Appendix: Fixed Exchange Rates,Interest Rates, and CapitalMobility 439

Chapter 21 Exchange Rate Regimes 44121 -1 The Medium Run 442

Aggregate Demand under Fixed ExchangeRates 443 • Equilibrium in the Short Runand in the Medium Run 444 • TheCase for and Against a Devaluation 445

21-2 Exchange Rate Crises under FixedExchange Rates 447

21-3 Exchange Rate Movements underFlexible Exchange Rates 450Exchange Rates and the Current Account45 1 • Exchange Rates and Current andFuture Interest Rates 452 • ExchangeRate Volatility 454

21-4 Choosing Between Exchange RateRegimes 455Common Currency Areas 455• Hard Pegs, Currency Boards,and Dollarization 458

Appendix: Deriving Aggregate Demandunder Fixed Exchange Rates 463Appendix: The Real Exchange Rate andDomestic and Foreign Real InterestRates 464

467

Chapter 22 Depressions and Slumps 46922-1 Disinflation, Deflation, and the

Liquidity Trap 470The Nominal Interest Rate, the Real InterestRate, and Expected Inflation 471 • TheLiquidity Trap 473 • Putting ThingsTogether: The Liquidity Trap andDeflation 476

22-2 The Great Depression 477The Initial Fall in Spending 479 • TheContraction in Nominal Money 480• The Adverse Effects of Deflation 481• The Recovery 482

22-3 The Japanese Slump 483

Contents

The Rise and Fall of the Nikkei 485• The Failure of Monetary and FiscalPolicy 486 • The JapaneseRecovery 488

Chapter 23 High Inflation 49523-1 Budget Deficits and Money

Creation 497

23-2 Inflation and Real Money

Balances 499

23-3 Deficits, Seignorage, andInflation 500The Case of Constant Nominal MoneyGrowth 501 • Dynamics and IncreasingInflation 504 • Hyperinflations andEconomic Activity 505

23-4 How Do HyperinflationsEnd? 506The Elements of a StabilizationProgram 506 • Can StabilizationPrograms Fail? 507 • The Costs ofStabilization 507

23-5 Conclusions 510

Money Growth Targets and TargetRanges 542 • Money Growth andInflation Revisited 542 • InflationTargeting 543 • Inflation RateRules 546

25-3 The Fed in Action 547The Mandate of the Fed 547 • The

• The

513

Chapter 24 Should Policymakers BeRestrained? 51524-1 Uncertainty and Policy 516

How Much Do MacroeconomistsActually Know? 5 1 6 * ShouldUncertainty Lead Policymakers to DoLess? 519 • Uncertainty and Restraintson Policymakers 519

24-2 Expectations and Policy 520Hostage Takings and Negotiations 521• Inflation and UnemploymentRevisited 521 • EstablishingCredibility 522 • Time Consistencyand Restraints on Policymakers 524

24-3 Politics and Policy 525Games Between Policymakers andVoters 525 • Games BetweenPolicymakers 527 • Politics andFiscal Restraints 529

Chapter 25 Monetary Policy: A SummingUp 53525-1 The Optimal Inflation Rate 536

The Costs of Inflation 537 • TheBenefits of Inflation 539 • The OptimalInflation Rate: The Current Debate 541

25-2 The Design of MonetaryPolicy 541

Organization of the Fed 547Instruments of Monetary Policy 548• The Implementation of Policy 550

Chapter 26 Fiscal Policy: A SummingUp 55526-1 The Government Budget

Constraint 556The Arithmetic of Deficits and Debt 556• Current versus Future Taxes 559• The Evolution of the Debt-to-GDPRatio 561

26-2 Four Issues in Fiscal Policy 563Ricardian Equivalence 564 • Deficits,Output Stabilization, and the CyclicallyAdjusted Deficit 565 • Wars andDeficits 566 • The Dangers of VeryHigh Debt 567

26-3 The U.S. Budget: Current Numbersand Future Prospects 569Current Numbers 569 • Medium-RunBudget Projections 571 • The Long-RunChallenges: Low Saving, Aging, andMedical Care 573

Chapter 27 Epilogue: The Story ofMacroeconomics 57927-1 Keynes and the Great

Depression 580

27-2 The Neoclassical Synthesis 580Progress on All Fronts 581 • The IS-IMModel 581 • Theories of Consumption,Investment, and Money Demand 581• Growth Theory 581• Macroeconometric Models 581• Keynesians versus Monetarists 582

27-3 The Rational ExpectationsCritique 583The Three Implications of RationalExpectations 584 • The Integration ofRational Expectations 585

27-4 Recent Developments 587New Classical Economics and RealBusiness Cycle Theory 587 • NewKeynesian Economics 588 • NewGrowth Theory 588 • Toward anIntegration 589

27-5 Common Beliefs 590

Contents

Chapter 28 The Global Crisis 59328-1 The Global Recession 59428-2 The Trigger: U.S. Housing Prices

Decline 59528-3 Amplification Mechanisms:

Leverage, Complexity, andLiquidity 597Leverage 597 • Complexity 598• Liquidity 600 • AmplificationMechanisms 600

28-4 From a Financial to aMacroeconomic Crisis 601The Decrease in U.S. GDP 601• From the United States to the Restof the World 604

Appendix

Appendix

Appendix

Glossary

Index

1

2

3

28-5 Policy Responses 605Monetary and Financial Policy 606• Fiscal Policy 609

28-6 Prospects for the Future 610

An Introduction to NationalIncome and Product Accounts A-l

A Math Refresher A-6

An Introduction toEconometrics A-12

G-1

1-1

Contents