Preface Preface I had two main goals in writing this book:
■ To make close contact with current macroeconomic events. What makes macroeconomics exciting is the light it sheds on what is happening around the world, from the major economic crisis which has engulfed the world since 2008, to monetary policy in the United States, to the problems of the Euro area, to growth in China. These events—and many more—are described in the book, not in footnotes, but in the text or in detailed boxes. Each box shows how you can use what you have learned to get an understanding of these events. My belief is that these boxes not only convey the “life” of macroeconomics, but also reinforce the lessons from the models, making them more concrete and easier to grasp.
■ To provide an integrated view of macroeconomics. The book is built on one underlying model, a model that draws the implications of equilibrium conditions in three sets of markets: the goods market, the financial markets, and the labor market. Depending on the issue at hand, the parts of the model relevant to the issue are developed in more detail while the other parts are simplified or lurk in the background. But the underlying model is always the same. This way, you will see macroeconomics as a coherent whole, not a collection of models. And you will be able to make sense not only of past macroeconomic events, but also of those that unfold in the future. New to this Edition The crisis that started in 2008, and is still lingering, forced macroeconomists to rethink much of macroeconomics. They clearly had understated the role of the financial system. They also had too optimistic a view of how the economy returned to equilibrium. Eight years later, I believe the main lessons have been absorbed, and this edition reflects the deep rethinking that has taken place. Nearly all chapters have been rewritten, and the main changes are as follows:
■ A modified Chapter 5, and a modified presentation of the IS-LM. The traditional treatment of monetary policy assumed that the central bank chose the money supply and then let the interest rate adjust. In fact, modern central banks choose the interest rate and then let the money supply adjust. In terms of the IS-LM model used to describe the short run, the LM curve, instead of being upward sloping, should be treated as flat. This makes for a more realistic and a simpler model.
■ A new Chapter 6. The chapter focuses on the role of the financial system in the economy. It extends the IS-LM model to allow for two interest rates, the interest rate set by monetary policy and the cost of borrowing for people or firms, with the state of the financial system determining the relation between the two.
■ A new Chapter 9. The traditional aggregate supply-
aggregate demand model was cumbersome and gave too optimistic a view of the return of output to potential. The model has been replaced by an IS-LM-PC model (where PC stands for Phillips curve), which gives a simpler and more accurate description of the role of monetary policy, and of output and inflation dynamics.
■ The constraints on monetary policy, coming from the zero lower bound, and the constraints on fiscal policy, coming from the high levels of public debt, are recurring themes throughout the book.
■ Many Focus boxes are new or extended. Among them: “Unemployment and Happiness” in Chapter 2; “The Liquidity Trap in the United Kingdom” in Chapter 4; Bank Runs in Chapter 6; “Why is the Natural Rate of Unemployment in Japan so Low?” in Chapter 8; “Okun’s Law” and “Deflation in the Great Depression” in Chapter 9; “The Construction of PPP Numbers” in Chapter 10; “The Role of Technology in the Decrease in Income Inequality in Latin America in the 2000s” in Chapter 13; “The Yield Curves for AAA-rated Central Government Bonds” in Chapter 14; “The Disappearance of Current Account Deficits in Euro Periphery Countries: Good News or Bad News?” in Chapter 18; “Euro Area Fiscal Rules: A Short History” in Chapter 21; and “Rules versus Discretion: New Absolute Budgetary Rules in the EU” and “How Japan Could Stand Such a Huge Debt?” in Chapter 22.
■ Figures and tables have been updated using the latest data available. xiv In short, I see this edition as the first true post-crisis macroeconomics textbook. I hope it gives a clear guide not only to what has happened, and also to what may happen in the future. Organization The book is organized around two central parts: A core, and a set of two major extensions. An introduction precedes the core. The two extensions are followed by a review of the role of policy. The book ends with an epilogue. A flowchart on the front endpaper makes it easy to see how the chapters are organized, and fit within the book’s overall structure.
■ Chapters 1 and 2 introduce the basic facts and issues of macroeconomics. Chapter 1 focuses first on the crisis, and then takes a tour of the world, from the United States, to Europe. Some instructors will prefer to cover Chapter 1 later, perhaps after Chapter 2, which introduces basic concepts, articulates the notions of short run, medium run, and long run, and gives the reader a quick tour of the book. While Chapter 2 gives the basics of national income accounting, I have put a detailed treatment of national income accounts to Appendix 1 at the end of the book. This decreases the burden on the beginning reader, and allows for a more thorough treatment in the appendix.
■ Chapters 3 through 13 constitute the core. Chapters 3 through 6 focus on the short run. These four chapters characterize equilibrium in the goods market and in the financial markets, and they derive the basic model used to study short–run movements in output, the IS–LM model. Chapter 6 is new, and extends the basic IS-LM model to take into account the role of the financial system. It then uses it to describe what happened during the initial phase of the crisis. Chapters 7 through 9 focus on the medium run. Chapter 7 focuses on equilibrium in the labor market and introduces the notion of the natural rate of unemployment. Chapter 8 derives and discusses the relation between unemployment and inflation, known as the Phillips curve. Chapter 9 develops the IS-LM-PC (PC for Phillips curve) model which takes into account equilibrium in the goods market, in the financial markets, and in the labor market. It shows how this model can be used to understand movements in activity and movements in inflation, both in the short and in the medium run. Chapters 10 through 13 focus on the long run. Chapter 10 describes the facts, showing the evolution of output across countries and over long periods of time. Chapters 11 and 12 develop a model of growth and describe how capital accumulation and technological progress determine growth. Chapter 13 focuses on the effects of technological progress on unemployment and on inequality, not only in the long run, but also in the short run and in the medium run.
■ Chapters 14 through 20 cover the two major extensions. Chapters 14 through 16 focus on the role of expectations in the short run and in the medium run. Expectations play a major role in most economic decisions, and, by implication, play a major role in the determination of output. Chapters 17 through 20 focus on the implications of openness of modern economies. Chapter 20 focuses on the implications of different exchange rate regimes, from flexible exchange rates, to fixed exchange rates, currency boards, and dollarization.
■ Chapters 21 through 23 return to macroeconomic policy. Although most of the first 20 chapters constantly discuss macroeconomic policy in one form or another, the purpose of Chapters 21 through 23 is to tie the threads together. Chapter 21 looks at the role and the limits of macroeconomic policy in general. Chapters 22 and 23 review fiscal and monetary policy. Some instructors may want to use parts of these chapters earlier. For example, it is easy to move forward the discussion of the government budget constraint in Chapter 22 or the discussion of inflation targeting in Chapter 23.
■ Chapter 24 serves as an epilogue; it puts macroeconomics in historical perspective by showing the evolution of macroeconomics in the last 70 years, discussing current directions of research, and the lessons of the crisis for macroeconomics. Alternative Course Outlines Within the book’s broad organization, there is plenty of opportunity for alternative course organizations. I have made the chapters shorter than is standard in textbooks, and, in my experience, most chapters can be covered in an hour and a half. A few (Chapters 5 and 9 for example) might require two lectures to sink in.
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