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Macroeconomics
SIXTH EDITION
Andrew B. Abel
The Wharton School of the
University of Pennsylvania
Ben S. Bernanke
Dean Croushore
Robins School of Business
University of Richmond
Boston San Francisco New York
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Library of Congress Cataloging-in-Publication Data
Abel, Andrew B., 1952Macroeconomics / Andrew B. Abel, Ben S. Bernanke, Dean Croushore. -6th ed.
p. em. - (Addison-Wesley series in economics)
Includes bibliographical references and indexes.
ISBN 0-321-41554-X
1. Macroeconomics. 2. United States-Economic conditions. 1. Bernanke, Ben.
II. Dean Croll shore. III. Title.
HBl72.5.A24
339-dc22
2008
2006052451
Copyright © 2008 Pearson Education, Inc.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or
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Suite 300, Boston, MA 02116, fax your request to 617-848-7047, or e-mail at www.pearsoned.com/lega l/
permissions.hlm.
ISBN 13: 978-0-321-41554-7
ISBN 10: 0-321-41554-X
1 2 3 4 5 6 7 8 9 10-DOW-1O 09 08 07 06
o rs
Andrew B. AbeL
The Wharton
School of the
University of
Pennsylvania
Ronald A. Rosen
feld Professor of
Finance a t The
Wharton School
and professor of economics at the Uni
versity of Pennsylvania, Andrew Abel
received his A.B. summa cum laude from
Princeton University and his Ph.D.
from the Massachusetts Institute of
Technology.
He began his teaching career at the
University of Chicago and Harvard Uni
versity, and has held visiting appoint
ments at both Tel Aviv University and
The Hebrew University of Jerusalem.
A prolific researcher, Abel has pub
lished extensively on fiscal policy, cap
ital formation, monetary policy, asset
pricing, and Social Security-as well as
serving on the editorial boards of
numerous journals. He has been hon
ored as an Alfred P. Sloan Fellow, a
Fellow of the Econometric Socie ty,
and a recipient of the John Kenneth
Galbraith Award for teaching excel
lence. Abel has served as a visiting
scholar at the Federal Reserve Bank of
Philadelphia, as a member of the Panel
of Economic Advisers at the Congres
sional Budget Office, and as a member
of the Technical Ad visory Panel on
Assumptions and Methods for the
Social Security Advisory Board. He is
also a Research Associa t e of the
National Bureau of Economic Research
and a member of the Advisory Board
of the Carnegie-Rochester Conference
Series.
Ben S.
Bernanke
Previously the
Howard Harrison
Gabrielle
and
Snyder Beck Pro
fessor of Economics and Public Affairs at
Princeton University, Ben Bernanke
received his B.A. in economics from Har
vard University sUlI1ma cllm laude-cap
turing both the Allyn Young Prize for
best Harvard undergraduate economics
thesis and the John H. Williams prize for
outstanding senior in the economics
department. Like coauthor Abel, he
holds a PhD. from the Massachusetts
Institute of Technology.
Bernanke began his career a t the
Stanford Graduate School of Business
in 1979. In 1985 he moved to Princeton
University, where he served as chair of
the Economics Department from 1995
to 2002. He has twice been visiting pro
fessor at M.I.T. and once at New York
University, and has taught in under
graduate, M.B.A., M.P.A., and Ph.D.
programs. He has authored more than
60 publications in macroeconomics,
macroeconomic history, and finance.
Bernanke has served as a visiting
scholar and advisor to the Federal
Reserve System. He is a Guggenheim
Fellow and a Fellow of the Econometric
Society. He has also been variously hon
ored as an Alfred P. Sloan Research
Fellow, a Hoover Institution National
Fellow, a National Science Foundation
Graduate Fellow, and a Research Asso
ciate of the National Bureau of Economic
Research. He has served as editor of the
American Economic Review. In 2005 he
became Chairman of the President's
Council of Economic Advisors. He is
currently Chairman and a member of
the Board of Governors of the Federal
Reserve System.
Dean
Croushore
Robins School of
Business, University
ofRichmond
Dean Croushore is
associate professor
of economics and
Rigsby Fellow at
the University of Richmond . He
received his A.B. from Ohio University
and his PhD. from Ohio State University.
Croushore began his career at Penn
sylvania State University in 1984. After
teaching for five years, he moved to the
Federal Reserve Bank of Philadel
phia, where he was vice president and
economist. His duties during his four
teen years a t the Philadelphia Fed
included heading the macroeconomics
section, briefing the bank's president
and board of directors on the state of the
economy and advising them about for
mulating monetary policy, writing arti
cles about the economy, administering
two national surveys of forecasters, and
researching current issues in monetary
policy. In his role a t the Fed, he crea ted
the Survey of Professional Forecasters
(taking over the defunct ASAjNBER
survey and revita lizing it) and devel
oped the Real-Time Data Set for Macro
economists.
Croushore returned to academia at
the University of Richmond in 2003.
The focus of his research in recent
years has been on forecasting and on
how data revisions affect monetary
policy, forecasting, and macroeconomic
research. Croushore's publications
include articles in many leading eco
nomics journals and a textbook on
money and banking. He is associate
editor of several journals and visiting
scholar at the Federal Reserve Bank of
Philadelphia.
v
•
ne
Prelace
on en s
xv
Introduction 1
PART 1
1 Introduction to Macroeconomics 2
2
The Measurement and Structure of the National Economy
long-Run Economic Performance
PART 2
23
61
3 Productivity, Output, and Employment 62
4 Consumption, Saving, and Investment 110
5 Saving and Investment in the Open Economy 173
6
Long-Run Economic Growth 212
7 The Asset Market, Money, and Prices 247
PART 3
Business Cycles and Macroeconomic Policy 281
8 Business Cycles 282
9 The IS-LM/AO-AS Model: A General Framework
for Macroeconomic Analysis
310
10 Classical Business Cycle Analysis: Market-Clearing Macroeconomics 360
11
Keynesianism: The Macroeconomics of Wage and Price Rigidity
PART 4
Macroeconomic Policy: Its Environment
and Institutions 443
12 Unemployment and Inflation 444
13 Exchange Rates, Business Cycles, and Macroeconomic Policy
in the Open Economy
476
14 Monetary Policy and the Federal Reserve System 529
15 Government Spending and Its Financing 573
Appendix A:
Glossarv
617
Name Index
Subject Index
VI
•
Some Useful Analytical Tools 610
629
631
398
•
e al e
Preface
xv
on en s
2.2 Gross Domestic Product
27
The Product Approach to Measuring GOP 27
PART 1 Introduction 1
BOX 2.1
Natural Resources, the Environment,
and the National Income Accounts
CHAPTER 1
30
The Expenditure Approach to Measuring GOP 31
Introduction to Macroeconomics
2
1. 1 What Macroeconomics Is About
The Income Approach to Measuring GOP 34
2
2.3 Saving and Wealth
37
Long-Run Economic Growth 3
Measures of Aggregate Saving 37
Business Cycles 4
The Uses of Private Saving 39
Unemployment 5
Relating Saving and Wealth 40
Inflation 6
APPLICATION
The International Economy 8
46
Real GOP 46
10
Price Indexes 48
Macroeconomic Forecasting
Macroeconomic Analysis
12
Macroeconomic Research
13
BOX 2.2 The Computer Revolution
11
1.2 What Macroeconomists Do
BOX 1.1
42
2.4 Real GOP, Price Indexes, and Inflation
Macroeconomic Policy 9
Aggregation
Wealth Versus Saving
and Chain-Weighted GDP
11
BOX 2.3 Does CPI Inflation Overstate Increases in the
Cost of Living?
14
Data Development
14
1.3 Why Macroeconomists Disagree
Classicals Versus Keynesians
51
2.5 Interest Rates
Developing and Testing
an Economic Theory
48
52
Real Versus Nominal Interest Rates 53
15
16
PART 2
A Unified Approach to Macroeconomics 18
CHAPTER 2
The M easurement and Structure
of the National Economy 23
2.1 National Income Accounting:
The Measurement of Production,
Income, and Expenditure 23
In Touch with the Macroeconomy:
The National Income and Product Accounts 25
Long-Run Economic
Performance 61
CHAPTER 3
Productivity. Output. and Employment
62
3.1 How Much Does the Economy Produce?
The Production Function 63
APPLICATION
The Production Function of the U.S.
Economy and U.S. Productivity Growth
64
The Shape of the Production Function 66
Supply Shocks
71
Why the Three Approaches Are Equivalent 26
VII
• •
viii
Detailed Contents
72
3.2 The Demand for Labor
APPLICATION
Consumer Sentiment
The Marginal Product of Labor and
Labor Demand: An Example 73
and Forecasts of Consumer Spending
A Change in the Wage 75
Effect of Changes in the Real Interest Rate 119
The Marginal Product of Labor and the
Labor Demand Curve 75
Fiscal Policy
Factors That Shift the Labor Demand Curve 77
Interest Rates
Aggregate Labor Demand
3.3 The Supply of Labor
Effect of Changes in Wealth
79
118
121
I n Touch with the Macroeconomy:
APPLICATION
79
115
4.2 Investment
122
A Ricardian Tax Cut?
1 25
127
The Income-Leisure Trade-off 80
The Desired Ca pitaI Stock
Real Wages and Labor Supply 80
Changes in the Desired Capital Stock 130
The Labor Supply Curve 83
APPLICATION
Aggregate Labor Supply 84
of Taxes on Investment
APPLICATION
Comparing U.S. and European
Labor Markets
85
From the Desired Capital
Stock to Investment 135
3.4 Labor Market Equilibrium
87
BOX 4.1
APPLICATION
90
APPLICATION
91
3.5 Unemployment
Investment and the Stock Market
139
Macroeconomic Consequences of the
Boom and Bust in Stock Prices
144
Appendix 4.A A Formal Model
of Consumption and Saving 156
93
Measuring Unemployment 94
In Touch with the Macroeconomy:
Labor Market Data 95
CHAPTER 5
Changes in Employment Status 95
How Long Are People Unemployed? 96
Saving and Investment in
the Open Economy 173
Why There Always Are Unemployed People 97
5.1 Balance of Payments Accounting
174
3.6 Relating Output and Unemployment:
Okun's Law 99
The Current Account 174
Appendix 3.A
The Balance of Payments Accounts 176
of Okun's Law
In Touch with the Macroec o no my:
The Growth Rate Form
109
The Capital and Financial Account 177
The Relationship Between the Current Account
and the Capital and Financial Account 179
CHAPTER 4
Consumption. Saving. and Investment
1 38
The Saving-Investment Diagram 140
Technical Change and
Wage Inequality
1 34
4.3 Goods Market Equilibrium
Output, Employment, and
the Real Wage During Oil Price Shocks
Measuring the Effects
Investment in Inventories and Housing 137
Full-Employment Output 89
APPLICATION
127
110
4.1 Consumption and Saving 111
BOX 5.1
Does Mars Have a Current
Account Surplus?
181
Net Foreign Assets and the Balance
of Payments Accounts 181
The Consumption and Saving
Decision of an Individual 112
APPLICATION
Effect of Changes in Current Income 114
as International Debtor
Effect of Changes in Expected Future Income 114
The United States
183
IX
Detailed Contents
CHAPTER 7
5.2 Goods Market Equilibrium
in an Open Economy 184
The Asset M arket, Money, and Prices
5.3 Saving and Investment in a
Small Open Economy 185
7.1 What Is Money?
The Effects of Economic Shocks in
a Small Open Economy 189
BOX 7.1
APPLICATION
APPLICATION
191
193
196
The Monetary Aggregates
251
Where Have All the Dollars Gone?
252
7.2 Portfolio Allocation and
the Demand for Assets 253
The Critical Factor: The Response
of National Saving 200
Expected Return 254
Risk 254
The Government Budget Deficit
and National Saving 201
The Twin Deficits
248
In Touch with the Macroeconomy:
BOX 7.2
5.5 Fiscal Policy and the
Current Account 199
APPLICATION
Money in a Prisoner-of-War Camp
The Money Supply 251
Recent Trends in the U.S.
Current Account Deficit
247
Measuring Money: The Monetary Aggregates 250
The Impact of Globalization
on the U.S. Economy
2 47
The Functions of Money 248
5.4 Saving and Investment in
Large Open Economies
•
Liquidity 254
Time to Maturity 255
202
Asset Demands 256
CHAPTER 6
Long-Run Economic G rowth
7. 3 The Demand for Money
212
The Price Level
6.1 The Sources of Economic G rowth
213
Growth Accounting 215
APPLICATION
The Post-1973 Slowdown
in Productivity Growth
APPLICATION
220
The Money Demand Function 259
Elasticities of Money Demand 261
Financial Regulation, Innovation,
and the Instability of Money Demand
7.4 Asset Market Equilibrium
The Fundamental Determinants of
Long-Run Living Standards 231
264
266
Asset Market Equilibrium: An
Aggregation Assumption 266
236
Endogenous Growth Theory 238
6.3 Government Policies to Raise
Long-Run Living Standards 240
Policies to Affect the Saving Rate 240
Policies to Raise the Rate of
Productivity Growth 241
Interest Rates 258
APPLICATION
Setup of the Solow Model 224
The Growth of China
Real Income 257
Velocity and the Quantity Theory of Money 262
6.2 Growth Dynamics:
The Solow Model 223
APPLICATION
257
Other Factors Affecting Money Demand 260
217
The Recent Surge in U.S.
Productivity Growth
256
The Asset Market Equilibrium Condition 268
7,5 Money Growth and Inflation
APPLICATION
269
Money Growth and Inflation
in European Countries in Transition
270
The Expected Inflation Rate and the
Nominal Interest Rate 272
APPLICATION
Measuring Inflation Expectations
273
x
Detailed Contents
PART 3
Business Cycles and
Macroeconomic Policy
CHAPTER 8
Business Cycles
281
8.1 What Is a Business Cycle?
283
9.2 The IS Curve: Equilibrium
in the Goods Market 313
Factors That Shift the IS Curve
The Pre-World War I Period 285
The Great Depression and World War II 285
Post-World War II U.s. Business Cycles 287
290
Factors That Shift the LM Curve 321
9.4 General Equilibrium in the
Complete IS-LM Model 325
291
Applying the IS-LM Framework: A Temporary
Adverse Supply Shock 326
In Touch with the Macroeconomy:
292
APPLICATION
Expenditure 294
BOX 9.1
Employment and Unemployment 295
InternationaI Aspects of the Business Cycle 300
the Business Cycle
301
Aggregate Demand and Aggregate Supply:
A Brief Introduction 302
Econometric Models and Macroeconomic
329
The Effects of a Monetary Expansion 330
Financial Variables 299
The Seasonal Cycle and
328
9.5 Price Adjustment and the Attainment
of General Equilibrium 330
Money Growth and Inflation 298
BOX 8.1
Oil Price Shocks Revisited
Forecasts for Monetary Policy Analysis
Average Labor Productivity and the
Real Wage 297
8.4 Business Cycle Analysis: A Preview
9.3 The LM Curve: Asset
Market Equilibrium 317
The Equality of Money Demanded
and Money Supplied 318
The Cyclical Behavior of Economic
Variables: Direction and Timing 290
Leading Indicators
315
The Interest Rate and the Price
of a Nonmonetary Asset 318
288
Have American Business Cycles
Become Less Severe? 288
Production
310
Factors That Shift the FE Line 312
8.2 The American Business Cycle:
The Historical Record 285
8.3 Business Cycle Facts
Framework for Macroeconomic Analysis
9.1 The FE Line: Equilibrium
in the Labor Market 311
282
The "Long Boom"
CHAPTER 9
The IS-LM/AO-AS Model: A General
301
Classical Versus Keynesian Versions of
the IS-LM Model 334
9.6 Aggregate Demand and Aggregate Supply
336
The Aggregate Demand Curve 336
The Aggregate Supply Curve 338
Equilibrium in the AD-AS Model 341
Monetary Neutrality in the AD-AS Model 341
Appendix 9.A Worked-Out Numerical Exercise
for Solving the IS-LMIAD-AS Model 351
Appendix 9.B Algebraic Versions of the IS-LM
and AD-AS Models 353
Detailed Contents
CHAPTER 10
11.2 Price Stickiness
Classical Business Cycle Analysis:
Market-Clearing Macroeconomics
361
The Real Business Cycle Theory 361
APPLICATION
11.3 Monetary and Fiscal Policy in
the Keynesian Model 412
Monetary Policy 412
Calibrating the Business Cycle
364
Fiscal Policy Shocks in the Classical Model 371
Unemployment in the Classical Model 375
Household Prod uction 377
10.2 Money in the Classical Model
406
Sources of Price Stickiness: Monopolistic
Competition and Menu Costs 406
360
10.1 Business Cycles in the Classical Model
Fiscal Policy 416
11.4 The Keynesian Theory of Business Cycles
and Macroeconomic Stabilization 419
Keynesian Business Cycle Theory 419
378
Macroeconomic Stabilization 422
Monetary Policy and the Economy 378
APPLICATION
Monetary Nonneutrality and Reverse Causation 378
Supply Shocks in the Keynesian Model 427
The Nonneutrality of Money: Additional
Evidence 379
BOX 11.2
10.3 The Misperceptions Theory and
the Nonneutrality of Money 380
3B7
Appendix 10.A Worked-Out Numerical
Exercise for Solving the Classical AD-AS
Model with Misperceptions 395
DSGE Models and the
Classical-Keynesian Debate
429
Appendix 11.C The Multiplier
in the Keynesian Model 441
PART 4
Appendix 10.B An Algebraic Version
of the Classical AD-AS Model with
Misperceptions 396
Macroeconomic Policy:
Its Enviro
nt and
Institutions 443
CHAPTER 12
CHAPTER 11
Unemployment and Inflation
Keynesi a n i sm: The Macroeconomics
of Wage and Price Rigid ity 398
11.1 Real-Wage Rigidity
444
12.1 Unemployment and Inflation:
Is There a Trade-Off? 445
399
Some Reasons for Real-Wage Rigidity
424
Appendix 11.B Worked-Out Numerical
Exercise for Calculating the Multiplier in a
Keynesian Model 439
Rational Expectations and the Role
of Monetary Policy 385
Are Price Forecasts Rational?
The Zero Bound
Appendix 11.A Labor Contracts and
Nominal-Wage Rigidity 436
Monetary Policy and the
Misperceptions Theory 383
BOX 10.1
XI
The Expectations-Augmented Phillips Curve 447
399
The Shifting Phillips Curve 451
The Efficiency Wage Model 400
Macroeconomic Policy and the Phillips Curve 455
Wage Determination in the
Efficiency Wage Model 401
BOX 12.1
Efficiency Wages and the FE Line 404
Henry Ford's Efficiency Wage
456
The Long-Run Phillips Curve 457
Employment and Unemployment in
the Efficiency Wage Model 402
BOX 11.1
The Lucas Critique
405
•
xii
Detailed Contents
12. 2 The Problem of Unemployment
458
458
The Costs of Unemployment
A Fiscal Expansion 499
The Long-Term Behavior of the
Unemployment Rate 459
12.3 The Problem of Inflation
A Monetary Contraction 502
462
The Costs of Inflation 462
BOX 12.2
Indexed Contracts
464
The Sacrifice Ratio
468
CHAPTER 13
Exchange Rates, B usi ness Cycles,
and M acroeconomic Policy i n the
Open Economy 476
477
Nominal Exchange Rates 477
Real Exchange Rates 478
Appreciation and Depreciation 480
Purchasing Power Parity 480
BOX 13.1
McParity
481
The Real Exchange Rate and Net Exports 483
APPLICATION
The Value of the Dollar
and U.S. Net Exports
504
Monetary Policy and the Fixed Exchange Rate 508
Fixed Versus Flexible Exchange Rates 511
The U.s. Disinflation of the
1980s and 1990s 469
13.1 Exchange Rates
13. 5 Fixed Exchange Rates
Fixing the Exchange Rate 505
Fighting Inflation: The Role of
Inflationary Expectations 466
BOX 12.3
13. 4 Macroeconomic Policy in an Open Economy
with Flexible Exchange Rates 499
485
13.2 How Exchange Rates Are Determined:
A Supply-and-Demand Analysis 487
I n Touch with the Macroeconomy:
Currency Unions 511
APPLICATION
European Monetary Unification
APPLICATION
Crisis in Argentina
Appendix 13.B An Algebraic Version
of the Open-Economy IS-LM Model 526
CHAPTER 14
Monetary Policy and the
Federal Reserve System
529
14.1 Principles of Money Supply
Determination 530
The Money Supply in an All-Currency
Economy 530
The Money Supply Under Fractional
Reserve Banking 531
Bank Runs 534
The Money Supply with Both Public Holdings
of Currency and Fractional Reserve Banking 535
Open-Market Operations 537
Macroeconomic Determinants of the Exchange
Rate and Net Export Demand 489
APPLICATION
The Open-Economy IS Curve 493
Factors That Shift the Open-Economy
IS Curve 495
The International Transmission
of Business Cycles 498
515
Appendix 13.A Worked-Out Numerical
Exercise for the Open-Economy
IS-LM Model 523
Exchange Rates 487
13. 3 The IS-LM Model for an
Open Economy 492
512
The Money Multiplier
During the Great Depression
538
14.2 Monetary Control in the United States
541
The Federal Reserve System 541
The Federal Reserve's Balance Sheet
and Open-Market Operations 542
Other Means of Controlling the Money Supply 543
Intermediate Targets 547
Making Monetary Policy in Practice
550
Detailed Contents
14.3 The Conduct of Monetary Policy: Rules
Versus Discretion 552
BOX 14.1
The Credit Channel
of Monetary Policy
BOX 14.2
The Monetarist Case for Rules
555
Rules and Central Bank Credibility 557
APPLICATION
Money-Growth Targeting
and Inflation Targeting
563
Other Ways to Achieve Central Bank
Credibility 566
591
The Burden of the Government
Debt on Future Generations 594
Budget Deficits and National Saving: Ricardian
Equivalence Revisited 594
Departures from Ricardian Equivalence 597
15.4 Deficits and Inflation
5 98
The Deficit and the Money Supply 598
Real Seignorage Collection and Inflation 600
CHAPTER 15
Government Spending
and Its Financing 573
15. 1 The Government Budget:
Some Facts and Figures 573
Government Outlays 573
Taxes 575
Deficits and Surpluses 579
15.2 Government Spending, Taxes,
and the Macroeconomy 581
Fiscal Policy and Aggregate Demand 581
Appendix 15.A
Incentive Effects of Fiscal Policy 584
Labor Supply and Tax
Reform in the 1980s
586
The Debt-GOP Ratio
Appendix A
Some Useful Analytical Tools
610
A.l Functions and Graphs 610
A.2 Slopes of Functions 611
A.3 Elasticities 612
A.4 Functions of Several Variables 613
A.5 Shifts of a Curve 614
A.6 Exponents 614
A.7 Growth Rate Formulas 614
Problems 615
Government Capital Formation 583
APPLICATION
Social Security:
How Can It Be Fixed?
554
589
The Growth of the Government Debt 589
APPLICATION
553
The Taylor Rule
15.3 Government Deficits and Debt
Glossary
617
Name Index
Subject Index
629
631
609
XIII
•••
xiv
Detailed Contents
s
Key Diagrams
mary Tables
1 Measures of Aggregate Saving 38
1
2 Comparing the Benefits and Costs of Changing
the Amount of Labor 75
2 The labor market
3 Factors That Shift the Aggregate
Labor Demand Curve 79
Determinants of Desired Investment
137
7 Equivalent Measures of a Country's
International Trade and Lending 182
8 The Fundamental Determinants
of Long-Run Living Standards 232
9 Macroeconomic Determinants
of the Demand for Money 260
10 The Cyclical Behavior of Key Macroeconomic
Variables (The Business Cycle Facts) 293
Factors That Shift the
Full-Employment (FE) Line 312
12 Factors That Shift the IS Curve 315
13 Factors That Shift the LM Curve 321
14 Factors That Shift the AD Curve
340
15 Terminology for Changes
in Exchange Rates 480
16
Determinants of the Exchange Rate
(Real or Nominal) 491
17 Determinants of Net Exports 492
18 International Factors
That Shift the IS Curve 498
19
3 The saving-investment diagram 149
5 National saving and investment
in large open economies 206
5 Determinants of Desired National Saving 125
11
103
4 National saving and investment
in a small open economy 205
4 Factors That Shift the Aggregate
Labor Supply Curve 85
6
The production function 102
Factors Affecting the Monetary Base, the Money
Multiplier, and the Money Supply 545
6 The IS-LM model 345
7 The aggregate demand-aggregate
supply model 346
8 The misperceptions version
of the AD-AS model 389
re ace
ince February 2006, Ben Bernanke has been chairman of the Board of Governors
of the Federal Reserve System. Federal ethics rules prohibited him from making
substantive contributions to the sixth edition. Dean Croushore, associate pro
fessor of economics and Rigsby Fellow at the University of Richmond, has helped
prepare this new edition as a coauthor. Dean has been closely associated with Macro
economics since the first edition, having written or co-written the Instructor's Manual
and Test Bank for the first through fifth editions, the Study Guide for the third through
fifth editions, and having assisted with manuscript preparation in previous editions,
taking a major role in the fifth edition. Dean has been able to draw on his fourteen
years of experience at the Federal Reserve Bank of Philadelphia, twelve of which as
head of the Macroeconomics Section, as well as his teaching experience at Penn State
University, Temple University, the Wharton School of the University of Pennsylvania,
Johns Hopkins University, Princeton University, and the University of Richmond, to
help keep the book fresh, applied to real-world economic developments, and
appealing to students.
In the sixth edition, we have added new material to keep the text up-to-date,
while building on the strengths that underlie the book's lasting appeal to instruc
tors and students, including:
Real-world applications. A perennial challenge for instructors is to help stu
dents make active use of the economic ideas developed in the text. The rich
variety of applications in this book shows by example how economic concepts
can be put to work in explaining real-world issues such as the contrasting
behavior of unemployment in the United States and Europe, the slowdown
and revival in productivity growth, the challenges facing the Social Security
system and the Federal budget, the impact of globalization on the u.s. economy,
and alternative approaches to making monetary policy. The sixth edition offers
new applications as well as updates of the best applications and analyses of
previous editions.
Broad modern coverage. From its conception, Macroeconomics has responded to
students' desires to investigate and understand a wider range of macroeconomic
issues than is permitted by the course's traditional emphasis on short-run fluc
tuations and stabilization policy. This book provides a modern treatment of these
traditional topics but also gives in-depth coverage of other important macro
economic issues such as the determinants of long-run economic growth, the
trade balance and financial flows, labor markets, and the institutional framework
of policymaking. This comprehensive coverage also makes the book a useful tool
for instructors with differing views about course coverage and topic sequence.
Reliance on a set of core economic ideas. Although we cover a wide range of topics,
we avoid developing a new model or theory for each issue. Instead we empha
size the broad applicability of a set of core economic ideas (such as the produc
tion function, the trade-off between consuming today and saving for tomorrow,
and supply-demand analysis). Using these core ideas, we build a theoretical
xv
xvi
Preface
framework that encompasses all the macroeconomic analyses presented in the
book: long-run and short-run, open-economy and closed-economy, and classi
cal and Keynesian.
A balanced presentation. Macroeconomics is full of controversies, many of which
arise from the split between classicals and Keynesians (of the old, new, and
neo-varieties). Sometimes the controversies overshadow the broad common
ground shared by the two schools. We emphasize that common ground. First,
we pay greater attention to long-run issues (on which classicals and Keynesians
have less disagreement). Second, we develop the classical and Keynesian
analyses of short-run fluctuations within a single overall framework, in which
we show that the two approaches differ principally in their assumptions about
how quickly wages and prices adjust. Where differences in viewpoint
remain for example, in the search versus efficiency-wage interpretations of
unemployment we present and critique both perspectives. This balanced
approach exposes students to all the best ideas in modern macroeconomics. At
the same time, an instructor of either classical or Keynesian inclination can
easily base a course on this book.
Innovative pedagogy. The sixth edition, like its predecessors, provides a variety
of useful tools to help students study, understand, and retain the material.
Described in more detail later in the preface, these tools include summary
tables, key diagrams, key terms, and key equations to aid students in organiz
ing their study, and four types of questions and problems for practice and
developing understanding, including problems that encourage students to do
their own empirical work, using data readily available on the Internet. Several
appendices illustrate how to solve numerical exercises that are based on the
algebraic descriptions of the IS-LM/AS-AD model.
N ew a n d U p d ated C o v e ra g e
What is taught in intermediate macroeconomics courses and how it is taught
has changed substantially in recent years. Previous editions of Macroeconomics
played a major role in these developments. The sixth edition provides lively cov
erage of a broad spectrum of macroeconomic issues and ideas, including a variety
of new and updated topics:
Long-term economic growth. Because the rate of economic growth plays a central
role in determining living standards, we devote much of Part 2 to growth and
related issues. We first discuss factors contributing to growth, such as produc
tivity (Chapter 3) and rates of saving and investment (Chapter 4); then in
Chapter 6 we turn to a full-fledged analysis of the growth process, using tools
such as growth accounting and the Solow model. Growth-related topics covered
include the post-1973 productivity slowdown, the factors that determine long
run living standards, and the productivity "miracle" of the 1990s. New to this edition:
The text now includes a discussion of the recent growth of China's economy.
International macroeconomic issues. We address the increasing integration of the
world economy in two ways. First, we frequently use cross-country compar
isons and applications that draw on the experiences of nations other than
the United States. For example, in Chapter 3, we compare U.s. and European
labor markets; in Chapter 6 we compare the long-term economic growth rates
U
•
Ion
CHAPTER
•
n ro u c I o n
•
acroeco n o m l cs
1.1
What Macroeconomics Is About
Macroeconomics is the study of the structure and performance of national
economies and of the policies that governments use to try to affect economic per
formance. The issues that macroeconomists address include the following:
What determines a nation 's long-run economic growth? In 1870, income per capita
was smaller in Norway than in Argentina. But today, income per capita is
about three times as high in Norway as in Argentina. Why do some nations'
economies grow quickly, providing their citizens with rapidly improving living
standards, while other nations' economies are relatively stagnant?
What causes a nation's economic activity to fluctuate? After nearly a decade of pros
perity during the 1980s, the U.s. economy began to falter in 1990. By the spring
of 1991, output in the United States had fallen by more than 1.5% from its level
nine months earlier. Economic growth was slow for a few more years before
rising sharply in 1994. But then, for the remainder of the 1990s, the U.s. econo
my grew rapidly. Why do economies sometimes experience sharp short-run
fluctuations, lurching between periods of prosperity and periods of hard times?
What causes unemployment? During the 1930s, one-quarter of the work force in
the United States was unemployed. A decade later, during World War II, less
than 2% of the work force was unemployed. Why does unemployment some
times reach very high levels? Why, even during times of relative prosperity, is
a significant fraction of the work force unemployed?
What causes prices to rise? The rate of inflation in the United States crept steadi
ly upward during the 1970s, and exceeded 10% per year in the early 1980s,
before dropping to less than 4% per year in the mid 1980s and dropping even
further to less than 2% per year in the late 1990s. Germany's inflation experi
ence has been much more extreme: Although Germany has earned a reputation
for low inflation in recent decades, following its defeat in World War I Germany
experienced an eighteen-month period (July 1922-December 1923) during
which prices rose by a factor of several billion! What causes inflation and what
can be done about it?
2
1.1
What Macroeconomics Is About
3
How does being part of a global economic system affect nations' economies? In the late
1990s, the U.s. economy was the engine of worldwide economic growth. The
wealth gained by Americans in the stock market led them to increase their
spending on consumer goods, including products made abroad, spurring
greater economic activity in many countries. How do economic links among
nations, such as international trade and borrowing, affect the performance of
individual economies and the world economy as a whole?
Can government policies be used to improve a nation's economic performance? In the
1980s and 1990s, the U.s. economy's output, unemployment rate, and inflation
rate fluctuated much less than they did in the 1960s and 1970s. Some econo
mists credit good goverrunent policy for the improvement in economic per
formance. How should economic policy be conducted so as to keep the
economy as prosperous and stable as possible?
Macroeconomics seeks to offer answers to such questions, which are of great
practical importance and are constantly debated by politicians, the press, and the
public. In the rest of this section, we consider these key macroeconomic issues in
more detail.
l o n g - R u n E c o n o m i c G rowth
If you have ever traveled in a developing country, you could not help but observe
the difference in living standards relative to those of countries such as the United
States. The problems of inadequate food, shelter, and health care experienced by the
poorest citizens of rich nations often represent the average situation for the people
of a developing country. From a macroeconomic perspective, the difference between
rich nations and developing nations may be summarized by saying that rich nations
have at some point in their history experienced extended periods of rapid economic
growth but that the poorer nations either have never experienced sustained growth
or have had periods of growth offset by periods of economic decline.
Figure 1.1 summarizes the growth in output of the U.s. economy since 1869.1 The
record is an impressive one: Over the past century and a third, the annual output of
U.s. goods and services has increased by more than 100 times. The performance of the
u.s. economy is not unique, however; other industrial nations have had similar, and
in some cases higher, rates of growth over the same period of time. This massive
increase in the output of industrial economies is one of the central facts of modern his
tory and has had enormous political, military, social, and even cultural implications.
In part, the long-term growth of the U.s. economy is the result of a rising pop
ulation, which has meant a steady increase in the number of available workers. But
another significant factor is the increase in the amount of output that can be pro
duced with a given amount of labor. The amount of output produced per unit of
labor input for example, per worker or per hour of work is called average labor
productivity. Figure 1 .2 shows how average labor productivity, defined in this
case as output per employed worker, has changed since 1900. In 2005, the average
U.s. worker produced more than six times as much output as the average worker
'Output is measured in Fig. 1.1 by two very similar concepts, real gross national product (real GNP)
until 1929 and real gross domestic product (real GOP) since 1929, both of which measure the physical
volume of production in each year. We discuss the measurement of output in detail in Chapter 2.
4
Chapter 1
Figure
1.1
Introduction to Macroeconomics
Output of the U.S.
economy, 1869-2005
In this graph the output
of the U.s. economy is
measured by real gross
domestic product (real
GOP) for the period
1929-2005 and by real
gross national product
(real GNP) for the period
prior to 1929, with goods
and services valued at
their 2000 prices in both
cases (see Chapter 2).
Note the strong upward
trend in output over
time, as well as sharp
fluctuations during
the Great Depression
(1929-1940), World War II
(1941-1945), and the
recessions of 1973-1975,
1981-1982, 1990-1991,
and 200l.
Sources: Real GNP ]869-1928
from Christina D. Romer,
"The Prewar Business Cycle
Reconsidered : New Estimates
of Gross National Product,
1869-1908," Jotlmal of Political
Economy, 97, 1 (February 1989),
pp. 22-23; real CDP 1929-2005
from FRED database, Federal
Reserve Bank of St. Louis,
resenrell.sflOllisfcd. orglfred2/seriesl
COpeA.
Data from Romer
were rescaled to 2000 prices.
-
;::I... tI'I
1
2
...
..!S
::1 o 0
_ "e
� g 10
O:: iil
-
�
o
-
2001
recess I O n
•
\
1990-1991
•
recession
8
.�
1981-1 982
.�
•
recesSIOn
.:::
- 6
1973-1975
recess ion
4
Great Depressi on Wor l d War II
(1929-1 940)
2
�
Wor ld War I
\
(1917-1918)
(1 941-1 945)
\
\
\
\
REA L
OUTPUT
��
8�7 0 1 880 1 890 1 900 1 9 1 0 1 920 1 930 1 940 1 950 1 960 1 970 1 980 1 990 2000 2005
Year
at the beginning of the twentieth century, despite working fewer hours over the
course of the year. Because today's typical worker is so much more productive,
Americans enjoy a significantly higher standard of living than would have been
possible a century ago.
Although the long-term record of productivity growth in the U.s. economy is
excellent, productivity growth slowed from the early 1970s to the mid-1990s and
only recently has picked up. Output per worker grew about 2.5% per year from
1949 to 1973, but only 1.1 % per year from 1973 to 1995. More recently, from 1995 to
2005, output per worker has increased 2.0% per year, a pace that has improved the
health of the U.s. economy significantly.
Because the rates of growth of output and, particularly, of output per worker
ultimately determine whether a nation will be rich or poor, understanding what
determines growth is one of the most important goals of macroeconomics. Unfor
tunately, explaining why economies grow is not easy. Why, for example, did
resource-poor Japan and Korea experience growth rates that transformed them in a
generation or two from war-torn nations into industrial powers, whereas several
resource-rich nations of Latin America have had erratic or even negative growth in
recent years? Although macroeconomists have nothing close to a complete answer
to the question of what determines rates of economic growth, they do have some
ideas to offer. For example, as we discuss in some detail in this book, most macro
economists believe that rates of saving and investment are important for growth.
Another key determinant of growth we discuss is the rate at which technological
change and other factors help increase the productivity of machines and workers.
B usi n e s s Cyc l es
If you look at the history of U.s. output in Fig. 1 .1, you will notice that the growth
of output isn't always smooth but has hills and valleys. Most striking is the period
between 1929 and 1945, which spans the Great Depression and World War II.
During the 1929-1933 economic collapse that marked the first major phase of the
1.1
Figure
What Macroeconomics Is About
5
1 .2
Average labor
productivity in the
United States,
1900-2005
Average labor produc
tivity (output per
employed worker) has
risen over time, with a
peak during World War II
reflecting increased
wartime production.
Productivity growth was
particularly strong in the
19505 and 19605, slowed
in the 19705, and picked
up again in the mid
19905. For the calculation
of productivity, output is
measured as in Fig. l.l.
� -
� � 90
� �
0� .g 80
",, 0
" 0
>' 0
O N
-
0. 0
= '"
�
Q.I
"'C
� "
" ..
0. ",
70
-= g 5 0
o. ..c:
,,
Wor ld Wa r II
-
o
-..
"
�
\
Mi d
60
40
Great
Depression
30
\
�
10
O L- �
1 900 1 9 1 0
__
\
1 970s
prod uct ivity
l owd own
s
1 950s-1960s
prod uct ivity
spee d up
AV ERAGE LA BO R
PR O D UCT IVITY
�
__
L-
__
__
1 920
1 930
-L
__
�
__
1 940
L-
__
__
1 950
-1990s
prod uct ivity
speed up
-L
__
1 960
�
__
__
1 970
�
__
1 980
-L
�
__
1 990
___
2000 2005
Year
Sources: Employment in
thousands of workers 14 and
older for 1 900-1947 from
Historical Stntistics of the Ullited
States, Colollial Times to 1970,
pp. 126�127; workers 16 and
older for 1948-2005 from
FRED database, Federal
Reserve Bank of St. Louis,
research.stlouisfed.orglfred/ series/
CE160V. Average labor pro
ductivity is output divided by
employment, where output is
from Fig. 1.1.
Great Depression, the output of the U.s. economy fell by nearly 30%. Over the
period 1939-1944, as the United States entered World War II and expanded pro
duction of armaments, output nearly doubled. No fluctuations in U.s. output since
1945 have been as severe as those of the 1929-1945 period. However, during the
postwar era there have been periods of unusually rapid economic growth, such as
during the 1960s and 1990s, and times during which output actually declined from
one year to the next, as in 1973-1975, 1981-1982, and 1990-199l.
Macroeconomists use the term business cycle to describe short-run, but some
times sharp, contractions and expansions in economic activity. 2 The downward
phase of a business cycle, during which national output may be falling or perhaps
growing only very slowly, is called a recession. Even when they are relatively mild,
recessions mean hard economic times for many people. Recessions are also a major
political concern, because almost every politician wants to be reelected and the
chances of reelection are better if the nation's economy is expanding rather than
declining. Macroeconomists put a lot of effort into trying to figure out what causes
business cycles and deciding what can or should be done about them. In this book
we describe a variety of features of business cycles, compare alternative explana
tions for cyclical fluctuations, and evaluate the policy options that are available for
affecting the course of the cycle.
U n e m p l oy m e nt
One important aspect of recessions is that they usually are accompanied by an
increase in unemployment, or the nwnber of people who are available for work and
are actively seeking work but cannot find jobs. Along with growth and business
cycles, the problem of unemployment is a third major issue in macroeconomics.
2A more exact definition is given in Chapter 8. Business cycles do not inc1ude fluctuations lasting only
a few months, such as the increase in activity that occurs around Christmas.
6
Chapter 1
Figure
1 .3
Introduction to Macroeconomics
The U.S.
unemployment rate,
1890-2005
The figure shows the
percentage of the civilian
labor force (excluding
people in the military)
that was unemployed in
each year since 1890.
Unemployment peaked
during the depression of
the 18905 and the Great
Depression of the 1930s,
and reached low points
in 1920 and during
World War II. Since
World War II, the highest
unemployment rates
occurred during the
1973-1975 and 1981-1982
receSSIOns.
.
-
".. ..v 30
C;
E
>,
o 0�
Q. .<>
E
.. � 25
-
_
" "
..
::J ;.:
••
>
••
v
-o 20
"
..
�
..
.9< 1 5
Stntistics of the Ullited Stntes,
Colol1ial Times to 1 970,
p. 135; for 1945--2()()S from FRED
database Federal Reserve Bank
of St. Louis, research.stlouisfed.
orglfred2/series/UNRATE.
/
1 890s
d epress i on
U N EMPLO YME N T
RATE
-
1 990-1991
1 981-1982
recession
1 973-1975
recession
War II
\
•
•
10
2001
5
O L- � -L
1 890 1 900 1 9 1 0
__
__
�
__
L-
__
__
�
__
-L
__
1920 1930 1 940
�
__
1950
L-
__
__
-L
__
-L
__
�
__
L-
__
_
1960 1 970 1 980 1 990 2000 2005
Year
Sources: Civilian
unemployment rate (people
aged 14 and older until 1 947,
aged 16 and older after 1947)
for 1 890-1947 from Historical
Great
Depress i on
The best-known measure of unemployment is the unemployment rate, which
is the number of unemployed divided by the total labor force (the number of
people either working or seeking work). Figure 1.3 shows the unemployment rate
in the United States over the past century. The highest and most prolonged period
of unemployment occurred during the Great Depression of the 1930s. In 1933, the
unemployment rate was 24.9%, indicating that about one of every four potential
workers was unable to find a job. In contrast, the tremendous increase in economic
activity that occurred during World War II significantly reduced unemployment. In
1944, at the peak of the wartime boom, the unemployment rate was 1.2%.
Recessions have led to significant increases in unemployment in the postwar
period. For example, during the 1981-1982 recession the U.s. unemployment rate
reached 10.8% 3 Even during periods of economic expansion, however, the unem
ployment rate remains well above zero, as you can see from Fig. 1 .3. In 2000, after
nine years of economic growth with no recession, the unemployment rate was still
about 4%. Why the unemployment rate can remain fairly high even when the econ
omy as a whole is doing well is another important question in macroeconomics.
I nf l a t i o n
When the prices of most goods and services are rising over time, the economy is
said to be experiencing inflation. Figure 1.4 shows a measure of the average level
3The unemployment rate was 10.8% in November and December 1982. The unemployment rate plotted
in Fig. 1.3 is not this high because the graph only shows annual data-the average unemployment
rate over the 12 months of each year-which was 9.7% in 1982.
Wh at M acroeconom i cs I s A b out
1.1
Figure
7
1 .4
Consumer prices in
the United States,
g
250
"'
1800-2005
.;:
Prior to World War II, the
average level of prices
faced by consumers
remained relatively flat,
with periods of inflation
(rising prices ) offset by
periods of deflation
(falling prices). Since
World War II, however,
prices have risen more
than tenfold. In the
figure, the average level
of prices is measured by
the consumer price index,
or CPJ (see Chapter 2).
The cpr measures the
cost of a fixed set, or
basket, of consumer
goods and services rela
tive to the cost of the
same goods and services
in a base period-in this
case, 1982-1984. Thus a
cpr of 195.30 in 2005
means that a basket of
consumer goods and
services that cost $100 in
1982-1984 would cost
$195.30 in 2005.
Sources: Consumer price index,
1800-1946 (1967
=
100) from
Historical Statistics of the Ullited
States, Colollial Times to 1970,
pp. 210-211; 1947-2005
(1982-1984 100) from FRED
database, Federal Reserve
Bank of St. Louis, researc1l.
=
t1011isfed.orglfred21series!
CPIAUCSL. Data prior to 1971
5
were rescaled to a base with
1982-1984 100.
=
�
c ....
-
CON SUMER
PRICE I NDEX
.- II
00
� � 200 I
�
s g;
= 0
:a
1 50 o
U
1 00 50 o
1 800
War of 1 8 1 2
inf lati on
( 1 8 1 2-1814)
Postwar
d efl at i on
I
/
I
1 820
I
1 840
Post-Wor ld
War II
in fl at i on
Def lat i on
Worl d War I of Great
Ci vi l War
i n flat i on
i nf lat i on
Depressi on
( 1 861-1 865 ) ( 1 9 1 7-1 9 1 8) ( 1 929-1933)
Postwar
d ef lati on
/
/
1 860
I
1 880
1 900
I
1920
I
I
1940
I
I
1 960
I
I
I
I I
1980 2000 2005
Year
of prices faced by consumers in the United States over the past two centuries.4 Note
that prior to World War II inflation usually occurred only during wartime, such as
during the War of 1812, the Civil War, and World War 1. These wartime periods of
inflation were followed by periods of deflation, during which the prices of most
goods and services fell. The result of these offsetting periods of inflation and defla
tion was that, over the long run, the level of prices was fairly constant. For exam
ple, prices at the end of World War I (1918) stood at about the same level as in 1800,
more than a century earlier.
The last significant deflation in the United States occurred during 1929-1933,
the initial phase of the Great Depression. Since then, inflation, without offsetting
deflation, has become the normal state of affairs, although inflation was fairly low
in the 1990s and early 2000s. Figure 1 .4 shows that consumer prices have risen sig
nificantly since World War II, with the measure of prices shown increasing tenfold.
The percentage increase in the average level of prices over a year is called the
inflation rate. If the inflation rate in consumer prices is 10%, for example, then on
average the prices of items that consumers buy are rising by 10% per year. Rates of
inflation may vary dramatically both over time and by country, from 1 or 2 percent
per year in low-inflation countries (such as Switzerland) to 1000% per year or more
in countries (such as a number of the former Soviet republics in the early 1990s) that
are experiencing hyperinflations, or extreme inflations. When the inflation rate
reaches an extremely high level, with prices changing daily or hourly, the economy
tends to function poorly. High inflation also means that the purchasing power of
money erodes quickly. This situation forces people to scramble to spend their money
almost as soon as they receive it.
4This measure is called the consumer price index, or CPT, which is discussed in Chapter 2. Conceptu
ally, the CPI is intended to measure the cost of buying a certain fixed set, or "basket," of consumer
goods and services. However, the construction of a consumer price index over a period as long as two
centuries involves many compromises. For instance, the basket of goods and services priced by the
CPT is not literally the same over the entire period shown in Fig. 1.4 but is periodically changed to
reflect the different mix of consumer goods and services available at different times.
8
Chapter 1
Introduction to Macroeconomics
T h e Int e rna t i ona l E c o n o m y
Today every major economy is an open economy, or one that has extensive trading
and financial relationships with other national economies. (In contrast, a closed
economy doesn't interact economically with the rest of the world.) Macroecono
mists study patterns of international trade and borrowing to understand better the
links among national economies. For example, an important topic in macroeco
nomics is how international trade and borrowing relationships can help transmit
business cycles from country to country.
Another issue for which international considerations are central is trade imbal
ances. Figure 1.5 shows the historical behavior of the imports and exports of goods
and services by the United States. U.s. imports are goods and services produced
abroad and purchased by people in the United States; U.s. exports are goods and
services produced in the United States and sold to people in other countries. To
give you a sense of the relative importance of international trade, Fig. 1.5 expresses
exports and imports as percentages of total U.s. output. Currently, both exports and
imports are larger fractions of U.s. output than they were during the 1950s and
Figure
1.5
U.S. exports and
imports, 1869-2005
The figure shows U.s.
exports (black) and U.S.
imports (red), each
expressed as a percent
age of total output.
Exports and imports
need not be equa I in each
year: U.s. exports
exceeded imports
(shaded gray) during
much of the twentieth
century. During the
1980s, 19905 and early
20005, however, U.s.
exports were smaller
than U.s. imports
(shaded red).
Sources: Imports and exports of
goods and services: 1869-1959
from Historical Statistics of tfle
United States, Colonial Times
to 1970. pp. 864-865;
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14
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13
12
11
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EXP O RTS
9
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7
6
IMP O RTS
5
1960-2005 from FRED
database, Federal Reserve
Bank of St. Louis, researclJ.
4
and BOPM; output is from
Fig. 1 . 1 .
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Year
1.1
What Macroeconomics Is About
9
1960s, reflecting both the recovery of trade from the disruptions of the Great
Depression and World War II and the trend toward greater economic interdepen
dence among nations. Note, though, that a century ago exports and imports
already were important relative to the size of the overall economy.
Figure 1 .5 demonstrates that exports and imports need not be equal in each
year. For example, following World War I and World War II, U.s. exports out
stripped U.s. imports because the country was sending large quantities of supplies
to countries whose economies had been damaged by war. When exports exceed
imports, a trade surplus exists. In the 1980s, however, U.s. exports declined sharply
relative to imports, a situation that has persisted through the 1990s and into the
2000s, as you can see from Fig. 1.5. This recent excess of imports over exports, or
trade deficit, has received considerable attention from policymakers and the news
media. What causes these trade imbalances? Are they bad for the U.s. economy or
for the economies of this country's trading partners? These are among the ques
tions that macroeconomists try to answer.
M a cr o e c o n o m i c P o l i cy
A nation's economic performance depends on many factors, including its natural
and human resources, its capital stock (buildings, machines, and software), its
technology, and the economic choices made by its citizens, both individually and
collectively. Another extremely important factor affecting economic performance is
the set of macroeconomic policies pursued by the government.
Macroeconomic policies affect the performance of the economy as a whole. The
two major types of macroeconomic policies are fiscal policy and monetary policy.
Fiscal policy, which is determined at the national, state, and local levels, concerns
government spending and taxation. Monetary policy determines the rate of
growth of the nation's money supply and is under the control of a government
institution known as the central bank. In the United States, the central bank is the
Federal Reserve System, or the Fed.
One of the main macroeconomic policy issues of recent years in the United
States has been in the realm of fiscal policy. Large Federal budget surpluses
emerged in the late 1990s, but these gave way to large Federal budget deficits,
exceeding $300 billion each year from 2003 to 2005. The recent behavior of the
Federal budget is put into a long-term perspective in Fig. 1 .6, which presents data
on Federal government spending and tax revenues for the past century and a
third 5 Again, so that their importance relative to the economy as a whole is indi
cated, spending, tax collections, and government budget deficits and surpluses
are expressed as percentages of total output.
Two obvious features of Fig. 1.6 are the peaks in government spending and
deficits that resulted from military buildups in World War I and World War II. At
its high point during World War II, Federal government spending exceeded 43%
of total output. Significant deficits also occurred during the Great Depression of
the 1930s because the government increased its spending on various programs
designed to help the economy, such as government-financed jobs programs.
SGovernment spending includes both government purchases of goods and services, such as purchases
of military equipment and the salaries of government officials, and government benefits paid to indi
viduals, such as Social Security payments.