ACKNOWLEDGMENTS

TMs book owes a great deal to many people. The book is an outgrowth of courses 1 have taught at Princeton, .1. ., Stanford, and especially Berkeley. I want to thank the many students in these courses for their feedback, their patience, and their encouragement.

Four people provided detailed, thoughtful, and constructive comments on almost every aspect of the book Laurence Ball, A. Andrew John, N. Gregory Mankiw, and Christina Romer. Each of them significantly improved the book, and 1 am deeply grateful to them for their efforts.

In addition, Susanto Basu, Matthew Gushing, Charles Engel, Mark Gertler, Mary Gregory, A. Stephen Holland, Gregory Linden, Maurice Obtsfeld, and Robert Rasche made valuable comments and suggestions concerning some or all of the book. Jeffrey Rohaly not only prepared the superb Solutions Manual to accompany the book, but also read the page proofs with great care and made many corrections. Teresa Cyrus helped with the preparation of some of the tables and figures. Finally, the editorial staff at McGraw-Hill and the production staff at Publication Services, Inc., especially Leon Jeter, Victoria Richardson, Scott Schriefer, Scott Stratford, and Lucille Sutton, did an excellent job of turning the manuscript into a finished product. I thank all of these people for their help.

INTRODUCTION

Macroeconomics is the study of the economy as a whole. It is therefore concerned with some of the most important questions in economics. Why are some countries rich and others poor? Why do countries grow? What are the sources of recessions and booms? Why is there unemployment, and what determines its extent? What are the sources of inflation? How do government policies affect output, unemployment, and inflation? These and related questions are the subject of macroeconomics.

This book is an introduction to the study of macroeconomics at an ad-\ anced level. It presents the major theories concerning the central questions of macroeconomics. Its goal is to provide both an overview of the field for students who will not continue in macroeconomics and a starting point for students who will go on to more advanced courses and research in macroeconomics and monetary economics.

The book takes a broad view of the subject matter of macroeconomics; it views it as the study not just of aggregate fluctuations but of other features of the economy as a whole. A substantial portion of the book is de-\ oted to economic growth, and separate chapters are devoted to theories of the natural rate of unemployment and to theories of inflation. Within each part, the major issues and competing theories are presented and discussed. Throughout, the presentation is motivated by substantive questions about the world. Models and techniques are used extensively, but they are treated as tools for gaining insight into important issues, not as ends in themselves.

The first three chapters are concerned with growth. The analysis focuses on two fundamental questions: Why are some economies so much richer than others, and what accounts for the huge increases in real incomes over time? Chapter 1 is devoted to the Solow growth model, which is the basic reference point for almost all analyses of growth. The Solow model takes technological progress as given and investigates the effects of the division of output between consumption and investment on capital accumulation and growth. The chapter presents and analyzes the model and assesses its ability to answer the central questions concerning growth.

Chapter 2 relaxes the Solow models assumption that the saving rate is exogenous and fixed. It covers both a model where the set of households

2 INTRODUCTION

in the economy is ftxed (the Ramsey model) and one where there is turnover (the Diamond model).

Chapter 3 presents the new growth theory. The ftrst part of the chapter explores the sources of the accumulation of knowledge, the allocation of resources to knowledge accumulation, and the effects of that accumulation on growth. The second part investigates the accumulation of human as well as physical capital.

Chapters 4 through 6 are devoted to short run fluctuations-the year-to-year and quarter-to-quarter ups and downs of employment, unemployment, and output. Chapter 4 investigates models of fluctuations where there are no imperfections, externalities, or missing markets, and where the economy is subject only to real disturbances. This presentation of real-busmess-cycle theory considers both a baseline model whose mechanics are fairly transparent and a more sophisticated model that incorporates additional important features of fluctuations.

Chapters 5 and 6 then turn to Keynesian models of fluctuations. These models are based on sluggish adjustment of nominal wages and prices, and emphasize monetary as well as real disturbances. Chapter 5 takes the existence of sluggish adjustment as given It hrst reviews the closed-economy and open-economy versions of the traditional IS-LM model. It then investigates the implications of alternative assumptions about price and wage rigidity, market structure, and inflationary expectations for the cyclical behavior of real wages, productivity, and markups, and for the relationship between output and inflation.

Chapter 6 examines the fundamental assumption of Keynesian models that nominal wages and prices do not adjust immediately to disturbances. The chapter covers the Lucas imperfect-information model, models of staggered adjustment of prices or wages, and new Keynesian theories of small frictions in price-setting. The chapter concludes with a brief discussion of theories of fluctuations based on coordination failures and real non-Walrasian features of the economy.

The analysis m the hrst six chapters suggests that the behavior of consumption and investment is central to both growth and fluctuations. Chapters 7 and 8 therefore investigate the determinants of consumption and investment m more detail. In each case, the analysis begins with a baseline model and then considers alternative views. For consumption, the baseline is the life-cycle/permanent-income hypothesis; for investment, it is q theory.

The final two chapters are devoted to inflation and unemployment. Chapter 9 begins by explaimng the central role of money growth m causing inflation and by investigating the effects of money growth on inflation, interest rates, and the real money stock. The remainder of the chapter considers two sets of theories of the sources of high money growth: theories emphasizing output-inflation tradeoffs (particularly theories based on the dynamic inconsistency of low-inflation monetary policy), and theories emphasizing governments need for revenue from money creation.