Macroeconomics. Manfred Gartner. Prentice Hall THIRD EDITION. University of St Gallen, Switzerland. An imprint of Pearson Education

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1 Macroeconomics THIRD EDITION Manfred Gartner University of St Gallen, Switzerland Prentice Hall FINANCIAL TIMES An imprint of Pearson Education Harlow, England London New York Boston San Francisco Toronto Sydney Tokyo Singapore Hong Kong Seoul Taipei New Delhi Cape Town Madrid Mexico City Amsterdam Munich Paris Milan

2 Guided tour of the book List of case studies and boxes Preface Publisher's acknowledgements xiv x vi xix xxiii 1 Macroeconomic essentials I 1.1 The issues of macroeconomics Essentials of macroeconomic accounting Beyond accounting 21 Chapter summary 26 Exercises 27 Recommended reading 29 Appendix: Logarithms, growth rates and logarithmic scales 30 2 Booms and recessions (I): the Keynesian cross The circular flow model revisited: terminology and overview Income determination: a first look Income determination: a second look An intertemporal view of consumption and investment 52 Chapter summary 59 Exercises 60 Recommended reading 62 Applied problems 62 3 Money, interest rates and the global economy The money market, the interest rate and the LM curve Aggregate expenditure, the interest rate and the exchange rate: the IS curve The IS-LM or the global-economy model 83 Chapter summary 93 Exercises 94 Recommended reading 96 Applied problems 96 4 Exchange rates and the balance of payments Globalization The exchange rate and the balance of payments Back to IS-LM: enter the FE curve Equilibrium in all three markets 114 Chapter summary I 19 Exercises 119

3 X Contents Recommended reading 121 Applied problems Booms and recessions (II): the national economy Fiscal policy in the Mundell-Fleming model Monetary policy in the Mundell-Fleming model The algebra of monetary and fiscal policy in the Mundell-Fleming model Comparative statics versus adjustment dynamics Adjustment dynamics with expected depreciation When prices move Today's exchange rate and the future 142 Chapter summary 144 Exercises 14-5 Recommended reading 146 Applied problems Enter aggregate supply Potential income and the labour market Why is there unemployment in equilibrium? Why may actual output deviate from potential output? 173 Chapter summary 176 Exercises 177 Recommended reading 17 Applied problems 17" 7 Booms and recessions (III): aggregate supply and demand 7.1 The short-run aggregate supply curve 7.2 The aggregate demand curve 7.3 The AD-AS model: basics Policy and shocks in the AD-AS model 195 Chapter summary 204 Exercises 205 Recommended reading 206 Appendix: The algebra of the AD curve Booms and recessions (IV): dynamic aggregate supply and demand The aggregate supply curve in an inflation-income diagram Equilibrium income and inflation: the DAD curve The DAD-SAS model Inflation expectations The DAD-SAS model at work 218 Chapter summary 232 Exercises 233 Recommended reading 234 Appendix: The algebra of the DAD curve 234

4 Contents XI Appendix: The genesis of the DAD-SAS model 235 Applied problems Economic growth (1): basics Stylized facts of income and growth The production function and growth accounting Growth theory: the Solow model Why incomes may differ What about consumption? Population growth and technological progress Empirical merirs and deficiencies of the Solow model 264 Chapter summary 267 Exercises 268 Recommended reading 269 Applied problems Economic growth (II): advanced issues The government in the Solow model Economic growth and capital markets Extending the Solow model and moving beyond Poverty traps in the Solow model Human capital Endogenous growth 294 Chapter summary 299 Exercises 300 Recommended reading 301 Appendix: A synthesis of the DAD-SAS and the Solow model 302 Applied problems Endogenous economic policy What do politicians want? Political business cycles Rational expectations Policy games Ways out of the time inconsistency trap 321 Chapter summary 326 Exercises 327 Recommended reading 328 Applied problems The European Monetary System and Euroland at work Preliminaries The 1992 EMS crisis Exchange rate target zones Speculative attacks Monetary and fiscal policy in the euro area 348 Chapter summary 354 Exercises.^55 Recommended reading 356

5 XII Contents Appendix: The two-country Mundell-Fleming model 356 Applied problems Inflation and central bank independence Inflation, central bank independence and the EMS Supply shocks and central bank independence Disinflations and the sacrifice ratio Lessons for European Monetary Union 385 Chapter summary 387 Exercises 388 Recommended reading 389 Applied problems Budget deficits and public debt The government budget The dynamics of budget deficits and the public debt Maastricht, the budget and the centra! bank What is wrong with having deficits and debt? Does monetary union need budget rules? 412 Chapter summary 416 Exercises 41/ Recommended reading 418 Applied problems Unemployment and growth Linking unemployment and growth European unemployment Persistence in the DAD-SAS model Lessons, remedies and prospects 443 Chapter summary 448 Exercises 449 Recommended reading 450 Applied problems Sticky prices and sticky information: new perspectives on booms and recessions (I) Reality checks: business cycle patterns and the DAD-SAS model New Keynesian responses The Phillips curves and monetary policy rules of current research Supply shocks in the DAD-SAS model 471 Chapter summary 473 Exercises 474 Recommended reading Real business cycles: new perspectives on booms and recessions (II) Real business cycle philosophy 477

6 Contents XIII 17.2 A real business cycle model A graphical real business cycle 492 Chapter summary 501 Exercises 502 Recommended reading 503 Appendix A: A primer in econometrics 504 A.I First task: estimating unknown parameters 505 A.2 Second task: testing hypotheses 507 A.3 A closer look at OLS estimation 509 Appendix summary 5 19 Exercises 520 Recommended reading 520 Appendix B: Glossary 521 Appendix C: Economics Nobel prize winners and earlier giants 535 Index 537 Supporting resources Visit to find valuable online resources. Companion Website for students Macroeconomic tutorials with interactive models, guided exercises and animations, plus an interactive road map connecting key concepts and models. A data bank with macroeconomic time series for many countries, along with a graphing module. Extensive links to valuable resources on the web, organized by chapter. Self-assessment questions to check your understanding, with instant grading. Index cards to aid navigation of resources, plus chapter summaries, macroeconomic dictionaries in several languages, and more. For instructors Downloadable Instructor's Manual including the solutions to chapter exercises and questions. Downloadable PowerPoint slides of all figures and tables from the book. For more information please contact your local Pearson Education sales representative or visit