Manfred Gartner. University of St Gallen, Switzerland. An imprint of Pearson Education

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1 Manfred Gartner University of St Gallen, Switzerland An imprint of Pearson Education Harlow, England London New York Reading, Massachusetts San Francisco Toronto Don Mills, Ontario Sydney Tokyo Singapore Hong Kong Seoul Taipei Cape Town Madrid Mexico City Amsterdam Munich Paris Milan

2 List of case studies and boxes Preface xv xvii 1 Macroeconomic essentials I 2 Booms and recessions (I): the Keynesian cross 33 3 Money, interest rates and the global economy 61 4 Exchange rates and the balance of payments 88 5 Booms and recessions (II): the national economy Enter aggregate supply Booms and recessions (III): aggregate supply and demand Booms and recessions (IV): dynamic aggregate supply and demand Economic growth (I): basics Economic growth (II): advanced issues Endogenous economic policy The European Monetary System and Euroland at work Inflation and central bank independence Budget deficits and public debt Unemployment and growth 401 Appendix: A primer in econometrics 434 Index 451

3 List of case studies and boxes Preface Publishers acknowledgements xv xvii xxi 1 MACROECONOMIC ESSENTIALS I 1.1 The issues of macroeconomics Essentials of macroeconomic accounting Beyond accounting 20 Chapter summary 25 Exercises 26 Recommended reading 28 Appendix: Logarithms, growth rates and logarithmic scales 29 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 50 Chapter summary 55 Exercises 56 Recommended reading 58 Applied problems 58 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 73 Chapter summary 83 Exercises 83 Recommended reading 85 Applied problems 85 4 EXCHANGE RATES AND THE BALANCE OF PAYMENTS Globalization The exchange rate and the balance of payments 91

4 4.3 Back to IS-LM: enter the FE curve Equilibrium in all three markets 102 Chapter summary 106 Exercises 107 Recommended reading 108 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 130 Chapter summary 132 Exercises 133 Recommended reading 134 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? 158 Chapter summary 161 Exercises 162 Recommended reading 163 Applied problems BOOMS AND RECESSIONS (III): aggregate supply and demand The short-run aggregate supply curve The aggregate demand curve The AD-AS model: basics Policy and shocks in the AD-AS model 180 Chapter summary 188 Exercises 189 Recommended reading 190 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 193

5 8.2 Equilibrium income and inflation: the DAD curve The DAD-SAS model Inflation expectations The DAD-SAS model at work 201 Chapter summary 214 Exercises 215 Recommended reading 216 Appendix: The algebra of the DAD curve 216 Appendix: The genesis of the DAD-SAS model 216 Applied problems ECONOMIC GROWTH (I): 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 merits and deficiencies of the Solow model 243 Chapter summary 247 Exercises 248 Recommended reading 249 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 275 Chapter summary 280 Exercises 281 Recommended reading 283 Appendix: A synthesis of the DAD-SAS and the Solow model 283 Applied problems ENDOGENOUS ECONOMIC POLICY What do politicians want? Political business cycles Rational expectations Policy games Ways out of the time inconsistency trap 299 Chapter summary 303

6 Exercises 304 Recommended reading 305 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 Euroland 328 Chapter summary 333 Exercises 334 Recommended reading 335 Appendix: The two-country Mundell-Fleming model 336 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 365 Chapter summary 367 Exercises 368 Recommended reading 369 Applied problems BUDGET DEFICITS AND PUBLIC DEBT The government budget The dynamics of budget deficits and the public debt Maastricht, the fisc and the central bank What is wrong with having deficits and debt? Does monetary union need budget rules? 393 Chapter summary 397 Exercises 398 Recommended reading 399 Applied problems UNEMPLOYMENT AND GROWTH Linking unemployment and growth European unemployment Persistence in the DAD-SAS model Lessons, remedies and prospects 423 Chapter summary 429

7 Exercises 429 Recommended reading 431 Applied problems 431 APPENDIX: A PRIMER IN ECONOMETRICS 434 A.I First task: estimating unknown parameters 435 A.2 Second task: testing hypotheses 437 A.3 A closer look at OLS estimation 439 Appendix summary 449 Exercises 450 Recommended reading 450 Index 451

8 Case studies 1.1 Germany's current account before and after unification Income vs leisure time in France and the USA How to pay for the war: Great Britain in Liquidity traps and Japan's prolonged recession Italy's current account before and after the 1992 EMS crisis The 1988 Asia crisis Ford's focus: an experiment in efficiency wages International evidence on the quantity equation and the AD curve Quantity equation, Fisher equation and purchasing power parity: international evidence Growth accounting in Italy Income and leisure choices in the OECD countries National incomes during the Second World War, east and west of the Atlantic Who wanted the euro? The role of past inflations German unification as a tug of war New Zealand's Reserve Bank Act: a case from down under The rise and fall of Ireland's public debt Who wanted the euro? The role of government debt Lessons from the Belgium-Luxemburg monetary union US vs European job growth: cutting the 'miracle' to size 425 Boxes 1.1 GDP as a measure of total output or income Working with graphs (part I) Actual income, potential income and steady-state income: Great Britain in What is money? Money versus interest rate control Working with graphs: (part II) Exchange rates Money supply vs interest control in a changing world Traditional vs new balance of payments terminology Interest rates, default risk and the risk premium The IS-LM-FE model in a different dress Endogenous and exogenous variables The Mundell-Fleming model under capital controls A flow model of the labour market The mathematics of the Cobb-Douglas production function 228

9 10.1 An illustration of the income and distribution effects of globalization Labour efficiency vs human capital: an example Convergence criteria in the Maastricht Treaty The Pact for Stability and Growth The SAS curve under fixed and flexible exchange rates Seignorage vs inflation tax revenue 387 A.I The coefficient of determination: R 2 443