(Test Bank) Macroeconomics

Charles,Jones, 5

Business

Test Bank

5th Edition

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Author(s): Charles, Jones

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Charles I. Jones Stanford University, Graduate School of BusinessMACROECONOMICS Fifth Edition MACRO5_ptr_ch00_fm_i-1.indd 1 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 1Cyan, Magenta, Yellow, BlackSEQUENCE rTXT 95108_TXT_r001.p1.pdf PAGE:FOLIO ITo Terry; for Audrey and Charlie 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 five hundred and hundreds 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 © 2021, 2018, 2014, 2011, 2010, 2008 by W. W. Norton & Company, Inc. All rights reserved Printed in Canada Editor: Eric Svendsen Editorial Assistant: Jeannine Hennawi, Ebby Bowles Project Editor: Layne Broadwater Production Manager: Ashley Horna Managing Editor, College Digital Media: Kim Yi Media Project Editor: Rachel Mayer Media Editor: Miryam Chandler Associate Media Editor: Victoria Reuter Media Editorial Assistant: Christina Fuery Marketing Manager, Economics: Janise Turso Art Director: Rubina Yeh Designer: Lissi Sigillo Composition: Graphic World, Inc. Manufacturing: Transcontinental Interglobe, Inc. 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 1 2 3 4 5 6 7 8 9 0 MACRO5_ptr_ch00_fm_i-1.indd 2 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 2BlackSEQUENCE rTXT 95108_TXT_r002.p1.pdf PAGE:FOLIO IIBRIEF 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 179 8 Inflation 211 PART 3 THE SHORT RUN 9 An Introduction to the Short Run 242 10 The Great Recession: A First Look 263 11 The IS Curve 286 12 Monetary Policy and the Phillips Curve 317 13 Stabilization Policy and the AS/AD Framework 355 14 The Great Recession and the Short-Run Model 393 15 DSGE Models: The Frontier of Business Cycle Research 427 PART 4 APPLICATIONS AND MICROFOUNDATIONS 16 Consumption 460 17 Investment 482 18 The Government and the Macroeconomy 508 19 International Trade 532 20 Exchange Rates and International Finance 559 21 Parting Thoughts 595 iii MACRO5_ptr_ch00_fm_i-1.indd 3 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 3Cyan, Magenta, Yellow, BlackSEQUENCE rTXT 95108_TXT_r003.p1.pdf PAGE:FOLIO IIIMACRO5_ptr_ch00_fm_i-1.indd 4 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 4--SEQUENCE rTXT 95108_TXT_r004.p1.pdf PAGE:FOLIO IVv 2.3 Measuring Changes over Time 29 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 3 An Overview of Long-Run Economic Growth 44 3.1 Introduction 45 3.2 Growth over the Very Long Run 45 3.3 Modern Economic Growth 47 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 58Preface xiii Acknowledgments xix About the Author xxiii PART 1 PRELIMINARIES 1 Introduction to 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 Summary 14 Key Concepts 14 Review Questions 15 Exercises 15 Worked Exercise 17 2 Measuring the Macroeconomy 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? 26CONTENTS MACRO5_ptr_ch00_fm_i-1.indd 5 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 5Cyan, Magenta, Yellow, BlackSEQUENCE rTXT 95108_TXT_r005.p1.pdf PAGE:FOLIO Vvi | Contents 5.3 Prices and the Real Interest Rate 108 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 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 5.7 Economic Growth in the Solow Model 116 Meanwhile, Back on the Family Farm 117 5.8 Some Economic Experiments 118 An Increase in the Investment Rate 118 A Rise in the Depreciation Rate 120 Experiments on Your Own 121 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 137 6.1 Introduction 138 6.2 The Economics of Ideas 139 Ideas 139 Nonrivalry 140 Increasing Returns 141 Problems with Pure Competition 143 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 Globalization and Ideas 155 Recapping Romer 155 6.4 Combining Solow and Romer: Overview 158 3.6 The Costs of Economic Growth 61 3.7 A Long-Run Roadmap 61 3.8 Additional Resources 62 Summary 63 Growth Rules 64 Key Concepts 64 Review Questions 64 Exercises 64 Worked Exercises 68 4 A Model of Production 70 4.1 Introduction 71 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 4.5 Evaluating the Production Model 95 Summary 96 Key Concepts 97 Review Questions 97 Exercises 98 Worked Exercises 100 5 The Solow Growth Model 102 5.1 Introduction 103 5.2 Setting Up the Model 104 Production 104 Capital Accumulation 104 Labor 106 Investment 106 The Model Summarized 107 MACRO5_ptr_ch00_fm_i-1.indd 6 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 6Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r006.p1.pdf PAGE:FOLIO VIContents | vii 8 Inflation 211 8.1 Introduction 212 8.2 The Quantity Theory of Money 216 Measures of the Money Supply 216 The Quantity Equation 218 The Classical Dichotomy, Constant Velocity, and the Central Bank 218 The Quantity Theory for the Price Level 219 The Quantity Theory for Inflation 220 Revisiting the Classical Dichotomy 222 8.3 Real and Nominal Interest Rates 223 8.4 Costs of Inflation 225 8.5 The Fiscal Causes of High Inflation 228 The Inflation Tax 228 Central Bank Independence 229 8.6 The Great Inflation of the 1970s 232 Summary 232 Key Concepts 233 Review Questions 233 Exercises 234 Worked Exercises 237 PART 3 THE SHORT RUN 9 An Introduction to the Short Run 242 9.1 Introduction 243 9.2 The Long Run, the Short Run, and Shocks 244 Trends and Fluctuations 244 Short-Run Output in the United States 246 Measuring Potential Output 249 The Inflation Rate 251 9.3 The Short-Run Model 251 A Graph of the Short-Run Model 252 How the Short-Run Model Works 253 The Empirical Fit of the Phillips Curve 254 Summary 255 9.4 Okun’s Law: Output and Unemployment 255 6.5 Growth Accounting 158 6.6 Concluding Our Study of Long-Run Growth 163 6.7 A Postscript on Solow and Romer 164 6.8 Additional Resources 165 Summary 166 Key Concepts 167 Review Questions 167 Exercises 167 Worked Exercises 170 6.9 appendix : Combining Solow and Romer (Algebraically) 172 Setting Up the Combined Model 172 Solving the Combined Model 172 Long-Run Growth 173 Output per Person 174 Transition Dynamics 175 More Exercises 177 7 The Labor Market, Wages, and Unemployment 179 7.1 Introduction 180 7.2 The U.S. Labor Market 180 The Dynamics of the Labor Market 183 7.3 Supply and Demand 184 A Change in Labor Supply 185 A Change in Labor Demand 186 Wage Rigidity 187 Different Kinds of Unemployment 189 7.4 The Bathtub Model of Unemployment 189 7.5 Labor Markets around the World 191 Hours of Work 194 7.6 How Much Is Your Human Capital Worth? 195 Present Discounted Value 195 Your Human Capital 196 7.7 The Rising Return to Education 197 7.8 Economic Growth and Income Inequality 203 Summary 204 Key Concepts 205 Review Questions 205 Exercises 205 Worked Exercises 207 MACRO5_ptr_ch00_fm_i-1.indd 7 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 7Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r007.p1.pdf PAGE:FOLIO VIIviii | Contents 11.4 Using the IS Curve 293 The Basic IS Curve 293 The Effect of a Change in the Interest Rate 294 An Aggregate Demand Shock 295 A Shock to Potential Output 297 Other Experiments 298 11.5 Microfoundations of the IS Curve 298 Consumption 298 Multiplier Effects 301 Investment 302 Government Purchases 303 Net Exports 309 11.6 Conclusion 309 Summary 310 Key Concepts 310 Review Questions 311 Exercises 311 Worked Exercises 314 12 Monetary Policy and the Phillips Curve 317 12.1 Introduction 318 12.2 The MP Curve: Monetary Policy and Interest Rates 319 From Nominal to Real Interest Rates 321 The IS-MP Diagram 322 Example: The End of a Housing Bubble 323 12.3 The Phillips Curve 326 Price Shocks and the Phillips Curve 329 Cost-Push and Demand-Pull Inflation 331 12.4 Using the Short-Run Model 332 The Volcker Disinflation 333 The Great Inflation of the 1970s 335 The Short-Run Model in a Nutshell 337 12.5 Microfoundations: Understanding Sticky Inflation 338 The Classical Dichotomy in the Short Run 338 12.6 Microfoundations: How Central Banks Control Nominal Interest Rates 341 Changing the Interest Rate 343 Why it instead of Mt? 343 12.7 Inside the Federal Reserve 346 Conventional Monetary Policy 346 Open-Market Operations: How the Fed Controls the Money Supply 347 9.5 Filling in the Details 258 Summary 258 Key Concepts 259 Review Questions 259 Exercises 260 Worked Exercise 262 10 The Great Recession: A First Look 263 10.1 Introduction 264 10.2 Recent Shocks to the Macroeconomy 265 Housing Prices 265 The Global Saving Glut 266 Subprime Lending and the Rise in Interest Rates 267 The Financial Turmoil of 2007–2009 268 Oil Prices 271 10.3 Macroeconomic Outcomes 272 A Comparison to Previous Recessions 272 Inflation 275 The Rest of the World 277 10.4 Some Fundamentals of Financial Economics 278 Balance Sheets 279 Leverage 280 Bank Runs and Liquidity Crises 281 Financial Wrap-Up 282 10.5 Going Forward 282 Summary 283 Key Concepts 283 Review Questions 284 Exercises 284 11 The IS Curve 286 11.1 Introduction 287 11.2 Setting Up the Economy 288 Consumption and Friends 289 The Investment Equation 289 11.3 Deriving the IS Curve 291 MACRO5_ptr_ch00_fm_i-1.indd 8 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 8Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r008.p1.pdf PAGE:FOLIO VIIIContents | ix 12.8 Conclusion 348 Summary 348 Key Concepts 349 Review Questions 349 Exercises 350 Worked Exercises 352 13 Stabilization Policy and the AS/AD Framework 355 13.1 Introduction 356 13.2 Monetary Policy Rules and Aggregate Demand 357 The AD Curve 358 Moving along the AD Curve 359 Shifts of the AD Curve 360 13.3 The Aggregate Supply Curve 360 13.4 The AS/AD Framework 361 The Steady State 362 The AS/AD Graph 362 13.5 Macroeconomic Events in the AS/AD Framework 363 Event #1: An Inflation Shock 363 Event #2: Disinflation 367 Event #3: A Positive AD Shock 369 Further Thoughts on Aggregate Demand Shocks 372 13.6 Empirical Evidence 373 Predicting the Fed Funds Rate 373 Inflation-Output Loops 374 13.7 Modern Monetary Policy 377 More Sophisticated Monetary Policy Rules 379 Rules versus Discretion 379 The Paradox of Policy and Rational Expectations 380 Managing Expectations in the AS/AD Model 381 Inflation Targeting 383 13.8 Conclusion 384 Summary 385 Key Concepts 386 Review Questions 386 Exercises 387 Worked Exercises 39014 The Great Recession and the Short-Run Model 393 14.1 Introduction 394 14.2 Financial Considerations in the Short-Run Model 395 Financial Frictions 395 Financial Frictions in the IS/MP Framework 396 Financial Frictions in the AS/AD Framework 398 The Dangers of Deflation 400 14.3 Policy Responses to the Financial Crisis 403 The Taylor Rule and Monetary Policy 403 How Large Is the Output Gap? 405 The Money Supply 406 The Fed’s Balance Sheet 408 The Troubled Asset Relief Program 412 Fiscal Stimulus 412 The European Debt Crisis 414 Financial Reform 415 14.4 The Aftermath of the Great Recession 417 Secular Stagnation 417 A Productivity Slowdown? 418 14.5 Conclusion 420 Summary 421 Key Concepts 421 Review Questions 422 Exercises 422 Worked Exercise 424 15 DSGE Models: The Frontier of Business Cycle Research 427 15.1 Introduction 428 15.2 A Brief History of DSGE Models 429 From Real Business Cycles to DSGE 430 Endogenous Variables 431 Shocks 431 Features 431 Mathematics and DSGE Models 432 MACRO5_ptr_ch00_fm_i-1.indd 9 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 9Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r009.p1.pdf PAGE:FOLIO IXx | Contents 15.3 A Stylized Approach to DSGE 433 Labor Demand 433 Labor Supply 434 Equilibrium in the Labor Market 435 15.4 Using the Stylized DSGE Model 436 A Negative TFP Shock 436 A Rise in Taxes Paid by Firms 437 A Rise in Government Purchases 438 Introducing Monetary Policy and Unemployment: Sticky Wages 440 Monetary Policy and Sticky Prices 442 Lessons from the Labor Market in DSGE Models 443 15.5 Quantitative DSGE Models 443 Impulse Response Functions 444 A Total Factor Productivity Shock 446 A Shock to Government Purchases 448 A Financial Friction Shock 449 15.6 Conclusion 450 Summary 451 Key Concepts 452 Review Questions 452 Exercises 452 Worked Exercise 454 15.7 appendix : Deriving the Labor Supply Curve 456 PART 4 APPLICATIONS AND MICROFOUNDATIONS 16 Consumption 460 16.1 Introduction 461 16.2 The Neoclassical Consumption Model 461 The Intertemporal Budget Constraint 461 Utility 462 Choosing Consumption to Maximize Utility 463 Solving the Euler Equation: Log Utility 465 Solving for ctoday and cfuture: Log Utility and b  1 466 The Effect of a Rise in R on Consumption 467 16.3 Lessons from the Neoclassical Model 467 The Permanent-Income Hypothesis 467 Ricardian Equivalence 469Borrowing Constraints 469 Consumption as a Random Walk 470 Precautionary Saving 471 16.4 Empirical Evidence on Consumption 472 Evidence from Individual Households 472 Aggregate Evidence 474 Summary 477 Key Concepts 478 Review Questions 478 Exercises 478 Worked Exercise 481 17 Investment 482 17.1 Introduction 483 17.2 How Do Firms Make Investment Decisions? 484 Reasoning with an Arbitrage Equation 484 The User Cost of Capital 485 Example: Investment and the Corporate Income Tax 486 From Desired Capital to Investment 490 17.3 The Stock Market and Financial Investment 492 The Arbitrage Equation and the Price of a Stock 492 P/E Ratios and Bubbles? 494 Efficient Markets 495 17.4 Components of Private Investment 498 Residential Investment 499 Inventory Investment 500 Summary 502 Key Concepts 503 Review Questions 503 Exercises 503 Worked Exercises 506 18 The Government and the Macroeconomy 508 18.1 Introduction 509 18.2 U.S. Government Spending and Revenue 509 Spending and Revenue over Time 510 The Debt-GDP Ratio 511 MACRO5_ptr_ch00_fm_i-1.indd 10 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 10Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r0010.p1.pdf PAGE:FOLIO XContents | xi 18.3 International Evidence on Spending and Debt 513 18.4 The Government Budget Constraint 514 The Intertemporal Budget Constraint 515 18.5 How Much Can the Government Borrow? 517 Economic Growth and the Debt-GDP Ratio 517 High Inflation and Default 518 Generational Accounting 519 Deficits and Investment 519 18.6 The Fiscal Problem of the Twenty-First Century 521 The Problem 522 Possible Solutions 525 18.7 Conclusion 527 Summary 528 Key Concepts 528 Review Questions 528 Exercises 529 Worked Exercise 530 19 International Trade 532 19.1 Introduction 533 19.2 Some Basic Facts about Trade 534 19.3 A Basic Reason for Trade 536 19.4 Trade across Time 537 19.5 Trade with Production 539 Autarky 540 Free Trade 542 Lessons from the Apple: Computer Example 543 19.6 Trade in Inputs 544 Moving Capital versus Moving Labor 545 19.7 The Costs of Trade 546 19.8 The Trade Deficit and Foreign Debt 549 Trade and Growth around the World 549 The Twin Deficits 550 Net Foreign Assets and Foreign Debt 552 19.9 Conclusion 553 Summary 554 Key Concepts 555 Review Questions 555Exercises 555 Worked Exercise 557 20 Exchange Rates and International Finance 559 20.1 Introduction 560 20.2 Exchange Rates in the Long Run 560 The Nominal Exchange Rate 560 The Law of One Price 561 The Real Exchange Rate 564 Summary 565 20.3 Exchange Rates in the Short Run 567 The Nominal Exchange Rate 567 The Real Exchange Rate 568 20.4 Fixed Exchange Rates 569 20.5 The Open Economy in the Short-Run Model 570 The New IS Curve 571 Event #1: Tightening Domestic Monetary Policy and the IS Curve 572 Event #2: A Change in Foreign Interest Rates 573 20.6 Exchange Rate Regimes 574 20.7 The Policy Trilemma 576 Which Side of the Triangle to Choose? 579 The Future of Exchange Rate Regimes 582 20.8 The Euro Crisis 584 The Crisis of 2011–2013 587 Long-Term Competitiveness 588 Summary 590 Key Concepts 591 Review Questions 591 Exercises 592 Worked Exercises 594 21 Parting Thoughts 595 21.1 What We’ve Learned 596 21.2 Significant Remaining Questions 598 21.3 Conclusion 601 Glossary 602 Index 617 MACRO5_ptr_ch00_fm_i-1.indd 11 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 11Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r0011.p1.pdf PAGE:FOLIO XIMACRO5_ptr_ch00_fm_i-1.indd 12 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 12--SEQUENCE rTXT 95108_TXT_r0012.p1.pdf PAGE:FOLIO XIIContents | xiii xiiiPREFACE TO THE FIFTH EDITION The macroeconomic events of the last twelve years are truly breathtaking—a once-in-a-life- time (we hope) occurrence. While the basics of how economists understand the macroeconomy remain solid, the global financial crisis and the Great Recession took us into waters that, if not un- charted, at least had 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 long- run economic performance has been surprisingly slow for more than a decade. It is a fascinating time to study macroeconom- ics, and I look forward to sharing facts about the macroeconomy with you and to discussing the Nobel- caliber ideas that help us understand them. This new edition continues the tradition estab- lished in previous versions: providing up-to-date, modern analysis of both current events and classic issues in macroeconomics. Key new additions in the fifth edition include • A case study in Chapter 6, “On the Possibility of Progress,” discussing the 2018 Nobel Prize to William Nordhaus and Paul Romer, which highlights a stunning decline in the real price of industrial commodities during the 20th century despite the enormous increase in demand, and the implications this has for growth in a world of finite resources; • A case study in Chapter 6 on “Is Economic Growth Slowing Down,” which highlights the new productivity slowdown that started around 2003, as well as a parallel case study at the end of Chapter 20 that notes the large declines in total factor productivity in several European countries over this same period, one of the fundamental problems facing the global economy; • A section in Chapter 7 on “Economic Growth and Income Inequality” that discusses the Distributional National Accounts approach of Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, showing one of their fascinating graphs of economic growth by income percentile for 1946–1980 and for 1980–2014; • A worked example of a TFP shock in the AS/ AD framework in Chapter 13, which helps to connect the long-run and short-run models and illustrates how it is possible for the economy to grow rapidly in the short-run without any inflationary pressures; • A section in Chapter 14 on “How Large is the Output Gap” showing that the decline in the output gap since 2007 has occurred in large part because of a slowdown in potential GDP rather than because of a rapid recovery of the economy; • A case study in Chapter 15 on “HANK Models” highlighting recent research on heterogeneous agent New Keynesian models that incorporates inequality into a frontier business cycle framework; and • Updates to data, exercises, and cases. Exercises in every chapter ask students to obtain and analyze up-to-date data, typically from the Federal Reserve’s FRED database. This fifth 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. MACRO5_ptr_ch00_fm_i-1.indd 13 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 13Cyan, Magenta, Yellow, BlackSEQUENCE rTXT 95108_TXT_r0013.p1.pdf PAGE:FOLIO XIIIxiv | Preface to the Fifth Edition Innovations (This section will make the most sense to instruc - tors and those students with some familiarity with macroeconomics. Students new to the subject may skip to the Guided Tour.) Most other books for teaching intermediate macroeconomics were first written more than twenty-five 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 de - voted 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, expos - ing students to the facts of the last several years and to critical concepts like leverage, balance sheets, and securitization. Chapter 14 (The Great Recession and the Short-Run Model), the last chapter of the short-run section, provides a de - tailed application of the short-run model to recent events, explaining in the process the unconven - tional aspects of monetary and fiscal policy that featured prominently in the government’s response to the crisis. Rich Treatment of Economic Growth Economic growth is the first major topic ex - plored in the book. After an overview chapter that describes the facts and some tools, Chapter 4 pre sents a (static) model based on a Cobb-Douglas production function. Students learn what a model is with this simple structure and see it applied to understanding the 50-fold differences in the per capita GDP observed across countries. Chapter 5 presents the Solow model but with no techno - logical change or population growth, which sim - plifies the presentation. Students learn Robert Solow’s insight that capital accumulation can - not serve as the engine for long-run economic growth. Chapter 6 offers something absent in most other intermediate macro books: a thorough exposition of the economics of ideas and Paul Romer’s insight that the discovery of new ideas can drive long-run growth. The approach taken in this book is to explain the macroeconomics of the long run before turning to the short run. It is much easier to understand fluctuations in macroeconomic aggregates when one understands how those aggregates behave in normal times. Familiar Yet Updated Short-Run Model The modern version of the short-run AS/AD model is the crowning achievement of the short- run section. By modern, I mean several things. First and foremost, the AS/AD graph is drawn with inflation on the vertical axis rather than the price level — perfect for teaching students about the threat of deflation that has reared its head fol - lowing the Great Recession, the Volcker disinfla - tion, and the Great Inflation of the 1970s. All the short-run analysis, including explicit dynamics, can be performed in this single graph. Another innovation in getting to the AS/AD framework is a focus on interest rates and the ab - sence of an LM curve. Chapter 12 explains how the central bank sets the interest rate. A 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. Chapter 13 introduces a simple version of John Taylor’s monetary policy rule to get the AD curve. A final innovation in the short-run model is that it features an open economy from the start: busi - ness cycles in the rest of the world are one source of shocks to the home economy. To keep things simple, however, the initial short-run model does not include exchange rates. MACRO5_ptr_ch00_fm_i-1.indd 14 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 14Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r0014.p1.pdf PAGE:FOLIO XIVPreface to the Fifth Edition | xv DSGE Models: The Frontier of Business Cycle Research A well-known tension exists between macro - economics that is taught in most intermediate courses and one that is practiced by policy makers, central bankers, and researchers. Traditionally, it has been thought that the more difficult mathe - matics used by practitioners necessitated this di - vide. However, in Chapter 15, I’ve found a way to bridge some of this gap by giving students insights into the much richer DSGE models typ - ically used to study macroeconomic fluctuations. Two innovations make this possible. First, I pres - ent the “impact effect” of shocks in a DSGE framework by studying the labor market. Second, I introduce impulse response functions graphi - cally and then show estimates of these dynamic effects using state-of-the-art methods, in particu - lar, the estimates of the famous Smets-Wouters model. Interplay between Models and Data A tight connection between models and data is a feature of modern macroeconomics, and this con - nection pervades the book. Many exercises ask students to work with real data, some of which are available in the book, some by using the on - line resources, and some from a data tool I’ve put together called Country Snapshots, a pdf file avail - able at www.stanford.edu/~chadj/snapshots.html that contains a page of graphs for each country in the world. The data underlying the graphs can be obtained as a spreadsheet simply by clicking on a link at the top of each page. Finally, exercises in every chapter ask students to obtain and ana - lyze up-to-date data, typically from the Federal Reserve’s FRED database. Worked Exercises at the End of Each Chapter One of the most effective ways to learn is by working through problems. So a carefully chosen collection of exercises is included at the end of each chapter; from among these, one or two are selected and worked out in detail. Students are en - couraged to attempt these exercises on their own before turning to the full solution.More Emphasis on the World Economy Relative to many intermediate macro books, this text features more emphasis on the world economy in three ways. First, the long-run growth chapters are a main emphasis in the book, and these inher - ently involve international comparisons. Second, the short-run model features an open economy (al - beit without exchange rates) from the very begin - ning. Finally, the book includes two international chapters in Part 4: Chapter 20 is the standard inter - national finance chapter and Chapter 19 is entirely devoted to international trade. Better Applications and Microfoundations Part 4 includes five chapters of applications and microfoundations. The basic structure of this part is traditional. There is a chapter for each compo - nent of the national income identity: consumption, investment, the government, and the international economy. However, the material inside is modern and novel. For example, the consumption chap - ter (Chapter 16) centers around the famous Euler equation that lies at the heart of today’s macro - economics. The investment chapter (Chapter 17) highlights the strong parallels between investment in physical capital and financial investments in the stock market using the “arbitrage equation” approach. The chapter on the government and the macroeconomy (Chapter 18) includes an ap - plication to what I call “The Fiscal Problem of the Twenty-First Century” — how to finance the growing expenditures on health care. And, as men - tioned above, the international section features two chapters, one on international trade and one on international finance. These chapters are not es - sential and instructors may wish to skip one or both of them depending on time constraints. A Guided Tour The book consists of three main parts: the Long Run, the Short Run, and the Applications and Microfoundations. Surrounding these parts are an introductory section (Part 1: Preliminaries) and a concluding chapter (Chapter 21: Parting Thoughts). This organization reflects an increasing apprecia - tion of the importance of long-run macroeconomics MACRO5_ptr_ch00_fm_i-1.indd 15 20/11/19 9:28 AM95108_INB Nov-25-2019 mikeb 15Cyan, Yellow, BlackSEQUENCE rTXT 95108_TXT_r0015.p1.pdf PAGE:FOLIO XV