Macroeconomic Policy (eBook)

Macroeconomic Policy 2
Foreword 7
Acknowledgments 10
Contents 13
About the Author 17
Introduction and Overview of the Second Edition 18
1.1 Chapter Overview 21
1.2 What’s New in This Second Edition 22
National Income Accounts 24
2.1 Paradigm Shifts: An Introduction 25
2.2 Some Fundamental Definitions 28
2.2.1 Inflation 30
2.2.2 GDP Deflator 30
2.2.3 Consumer Price Index (CPI) 31
2.2.4 Which Measure Does the Fed Use? 34
2.3 Discussion Questions 35
Budget Deficits, Trade Deficits, and Global Capital Flows: The National Savings Identity 40
3.1 The National Savings Identity 40
3.1.1 Two Crucial Assumptions Underlying the NSI 43
3.1.1.1 Microeconomics Review 44
3.1.2 Linking the Twin Deficits 45
3.2 Possible Negative Aspects of Bond Financed Deficits 49
3.2.1 Crowding Out 49
3.2.2 Trade Deficits 50
3.3 Two Cases of the NSI: The United States and China 51
3.3.1 US-Type NSI 51
3.3.2 China-Type NSI 52
3.4 Factors Influencing Global Capital Flows 52
3.4.1 Hot Capital: Southeast Asia, Mexico, Iceland 53
3.5 Discussion Questions 55
Aggregate Demand: Setting the Stage for Demand-Side Stabilization 64
4.1 Demand-Side Stabilization 64
4.2 Business Cycles 66
4.3 Variables Underlying the Aggregate Demand: Introducing the Goods Market 67
4.3.1 Analyzing the Components of Aggregate Demand 70
4.3.2 Deriving the Aggregate Demand 78
4.4 Discussion Questions 80
Demand-Side Stabilization: Overheating, Hard Landing, and Everything in Between 86
5.1 Shifting the AD: Changing Government Spending 86
5.1.1 The Mechanism of the Multiplier Effect 87
5.2 Shifting the AD: Changing Monetary Policy 92
5.3 Shifting the AD: Tax Policy 93
5.4 Summarizing the Three Methods of Shifting AD 94
5.5 Unemployment 95
5.6 Inflation 99
5.6.1 Designing Macroeconomic Policy: An Exercise 99
5.6.1.1 Objective 99
5.6.1.2 Case A: 101
5.6.2 Demand-Pull Inflation 101
5.6.3 Cost-Push Inflation 108
5.6.4 The Index of Leading Economic Activity, NAPM, and Some ‘‘Non-traditional’’ Indicators 110
5.7 Discussion Questions 113
Long-Term Interest Rates, the Yield Curve, and Hyperinflation 123
6.1 Expected Inflation and Long-Term Interest Rates: The Fisher Effect 123
6.2 The Yield Curve: A Macroeconomic Perspective 126
6.2.1 Negative Real Rates and SAP Bubbles 130
6.3 Hyperinflations 131
6.3.1 The Anatomy of a Meltdown 131
Author’s Note: 133
6.3.2 Hyperinflations: Remedies 135
6.4 Monetary Discipline: The Hazards of Pegging 137
6.5 Discussion Questions 140
ISLM: The Engine Room 147
7.1 The IS Curve 148
7.1.1 Some IS Exercises 149
7.1.2 Introducing Taxes into the IS Curve 150
7.2 The LM Curve 152
7.2.1 Factors that Shift the LM 154
7.3 ISLM - ADAS Policy Exercises 157
7.3.1 Survival Guide to ISLM-ADAS Policy Analysis 157
7.3.2 ISLM - ADAS Policy Experiment I 157
7.3.3 ISLM - ADAS Policy Experiment II 160
7.3.4 ISLM - ADAS Policy Exercise III An Increase in Tax Rates 163
7.3.5 ISLM-ADAS Policy Exercise IV: Simultaneous Increases in Government Spending and Monetary Growth (‘‘Fine Tuning ’’) 165
7.4 Summarizing IS and LM Shifts 167
7.5 The Global IS 167
7.5.1 Global IS: A Brief Overview 167
7.5.1.1 Summarizing Factors that Shift the Global IS 171
7.6 Discussion Questions 171
The Classical Model 175
8.1 Classical Aggregate Supply: Derivation 175
8.1 Derivation Sequence 179
8.2 Policy Exercise I: Increase in G 180
8.3 ISLM - ADAS Policy Exercise II: Increase in M 183
8.4 The ‘‘ Natural’’ Rates of GDP and Employment Growth 184
8.5 Discussion Questions 186
The Keynesian Model 191
9.1 Keynesian Aggregate Supply: Diagrammatic Derivation 192
9.1.1 Derivation Sequence 193
9.2 Survival Guide for ISLM with Keynesian AS (K-AS) 194
9.2.1 Policy Exercise I: Increase in G 195
9.2.2 Policy Exercise II: Increase in Monetary Growth 198
9.2.2.1 From Stage 2 to Overheating 200
9.2.3 Policy Exercise III: Engineering a Soft-Landing 201
9.2.4 Policy Exercise IV When Low Interest Rates Don’t Work-Increasing M Against A Backdrop of Collapsed Confidence 203
9.3 The Phillips Curve 205
9.4 The Yield Curve and the Keynesian Paradigm 206
9.5 The Agony of a Paradigm Shift: The Great Depression 209
9.5.1 Mistake 1: Wage Floors 209
9.5.2 Mistake 2: Tax Increases and Decreases in G 210
9.5.3 Mistake 3: Liquidity Crisis 211
9.5.4 Mistake 4: Smoot-Hawley 212
9.5.4.1 Could a Great Depression Happen Again? 213
9.6 Discussion Questions 214
The Supply-Side Model and the New Economy 222
10.1 The Expectations-Augmented AS Curve: An Explanation of the Paradigm Shift 223
10.1.1 Diagrammatic Derivation: Expectations-Augmented Aggregate Supply Curve 225
10.1.2 Paradigm Shift II: An Expectations-Augmented Explanation 226
10.2 Supply-Side Economics 229
10.2.1 Significant Income Tax Cuts 229
10.2.2 Sweeping Corporate/Business Tax Cuts 231
10.2.3 Deregulation 232
10.2.4 Supply-Side Stabilization 233
10.3 Stagflation 235
10.4 From the Supply-Side to the New Economy 236
10.5 The Identification Problem 239
10.6 A Keynesian Explanation of the ‘‘ New ’’ Economy 241
10.7 Contrasting the ‘‘New’’ Economy with the ‘‘Old’’ One 243
10.8 Can the Two Models Be Reconciled? 245
10.9 The Outlook for the New Economy 248
10.10 Which Model for Developed Economies? 249
10.11 Discussion Questions 250
Central Banks and Monetary Policy 259
11.1 Institutional Framework: The Federal Reserve 259
11.2 The Money Creation Process: How the Federal Reserve Changes the Money Supply 261
11.2.1 Reserve Requirements and the Money Multiplier: The Theory 262
11.2.2 Open Market Operations (OMOs) 263
11.2.2.1 Reserve Ratios and the Money Multiplier: The Empirical Reality 266
11.2.3 Changing the Discount Rate 268
11.2.3.1 How is Discount Rate Policy Supposed to Change Money Growth? 268
11.2.3.2 How is Observed (Actual) Discount Rate Policy Different? 268
11.2.4 Changing the Required Reserve Ratio 269
11.3 The Role of the Central Bank: How Should Monetary Policy be Conducted? 269
11.3.1 Milton Friedman and the Role of Monetary Policy 270
11.3.2 IS Monetary Discipline Worth the Pain? 275
11.3.3 The ‘‘Curse’’ of Humphrey-Hawkins 276
11.3.3.1 Is the Humphrey-Hawkins Act Really a Liability? 277
11.3.4 The Taylor Rule 278
11.3.5 Exchange Rate Pegging, Currency Crises, and Sterilization 279
11.3.5.1 The Impossible Trinity 284
11.4 Discussion Questions 285
Bibliography 294
Index 297