Chapter Title Pages Macroeconomics: a succinct introduction 3-41 Solving Rational Expectations Models 42-86 Partial Information and Signal Extraction 87-104 Stabilization Policy – Can we? 107-133 Stabilization Policy – Should we? 134-164 Practical issues of effective stabilization 165-181 Fiscal Policy and the government budget constraint 182-211 The political economy of democracy 212-231 Unemployment, productivity and growth 232-250 10 The Macroeconomics of an Open Economy 253-271 11 Representative agent models in cashless economies 272-305 12 Money in representative agent models 306-320 13 Open economy representative agent models 321-331 14 Testing the Rational Expectations Hypothesis 335-422 15 Interpreting the Evidence: The Problem of Observational Equivalence 423-433 16 Direct Tests of Rational Expectations 434-443 17 Where are we going? 444-446 18 Time-series annex: an introduction of linear and nonlinear time series 447-490 Bibliography 491-526 Errata page Corrigenda pages Pdfurhfrqrplfv= d vxfflqfw lqwurgxfwlrq Iru pdq| srvwjudgxdwhv pdfurhfrqrplfv lv d wrwdoo| qhz vxemhfw1 Iru vrph xqghujudgxdwhv/ lw lv xvhixo wr kdyh d elug*v h|h ylhz ri wkh ed0 vlfv ri wkh vxemhfw ehiruh soxqjlqj lqwr pruh dgydqfhg pdwhuldo1 Wklv fkdswhu wkhuhiruh vnhwfkhv lq vrph edvlf hohphqwv ri pdfurhfrqrplfv dv d irxqgdwlrq iru zkdw iroorzv1 Lw wdnhv qrwklqj iru judqwhg h{fhsw d nqrzohgjh ri hohphqwdu| plfurhfrqrplfv  hvvhqwldoo| vxsso| dqg gh0 pdqg1 Pdfurhfrqrplfv lv derxw wkh ehkdylrxu ri zkroh hfrqrplhv exw vlqfh wkhvh duh pdgh xs ri lqglylgxdov dqg upv dfwlqj lq wkh pdunhw0 sodfh wrjhwkhu zlwk rwkhu lqvwlwxwlrqv olnh jryhuqphqwv wkdw duh uhvsrq0 vleoh wr lqglylgxdov/ lw lv qdwxudo wr wklqn ri rxu xqghuvwdqglqj frplqj iurp plfurhfrqrplfv zklfk dqdo|vhv krz shrsoh lqwhudfw lq d sduwlfxodu pdunhw dqg exlog xs wkh zkroh hfrqrp| iurp wkhuh1 Wkdw lv krz wkh cfodvvlfdo* hfrqrplvwv  wkrvh zkr zurwh ehiruh Mrkq Pd|qdug Nh|qhv  qdwxudoo| dqdo|vhg wkh hfrqrp|1 Zkloh wkhlu wklqnlqj zdv iru d orqj wlph ryhuodlg e| wkh zrun ri Nh|qhv dqg klv iroorzhuv/ lq uhfhqw wlphv lw kdv rqfh djdlq ehfrph wkh fruh ri rxu pdfurhfrqrplf dqdo|vlv> zh vkdoo ehjlq zlwk wkh hduo| fodvvlfdo wklqnlqj/ wkhq vnhwfk lq wkh lghdv ri Nh|qhv dqg ri klv odwhu iroorzhuv/ ehiruh exloglqj xs wkh prghuq pdfurh0 frqrplf wkhru| wkdw uhvwv hvvhqwldoo| rq fodvvlfdo irxqgdwlrqv zlwk vrph h{wud hohphqwv gudzq iurp Nh|qhv* zrun1 Wklv dssurdfk/ yld d vkruw klvwru| ri pdfurhfrqrplf wkrxjkw/ lv wkh hdvlhvw zd|/ h{shulhqfh vkrzv/ wr uhdfk dq xqghuvwdqglqj ri prghuq wkrxjkw1 +Vwxghqwv pd| olnh wr frqvxow d jrrg lqwhuphgldwh wh{werrn vxfk dv Sdunlq dqg Edgh/ Prghuq Pdfurhfrqrplfv/ dq| hglwlrq/ lq frqmxqfwlrq zlwk wklv fkdswhu1, Prghov ri wkh Hfrqrp| WKH FODVVLFDO PRGHO Wkh qdwxudo vwduwlqj srlqw iru pdfurhfrqrplfv lv wkh fodvvlfdo prgho/ zkhuh lw lv dvvxphg wkdw sulfhv dqg zdjhv duh h{leoh dv lq wkh idploldu plfurhfrqrplf prgho ri d pdunhw zlwk vxsso| dqg ghpdqg1 Wkh glhu0 hqfh iurp wkdw prgho lv wkdw vxsso| dqg ghpdqg duh iru wkh djjuhjdwh ri doo djhqwv lq wkh hfrqrp|  lw lv dvvxphg wkdw rqh fdq phdqlqjixoo| djjuhjdwh xs ru dyhudjh wkh ehkdylrxu ri doo lq wklv zd|> lpsolflwo| zh dvvxph wkdw zkhq lqfrph ru dfwlylw| lv uhglvwulexwhg dfurvv shrsoh ru upv wkh dyhudjh lv qrw pxfk dhfwhg vr wkdw zh fdq irfxv rq wkh dyhu0 djh irufhv dhfwlqj wkh hfrqrp| udwkhu wkdq rq wkhlu glvwulexwlrq dfurvv djhqwv1 Djjuhjdwh vxsso| lq wklv wkhru| ghshqgv rq whfkqrorj|/ suhihu0 hqfhv dqg uhodwlyh sulfhv1 Ghpdqg ghshqgv rq wkh txdqwlw| ri prqh| dqg rq lqfrphv1 Vxsso| Iljxuh 414 vkrzv irxu txdgudqwv/ erwwrp ohiw lv wkh oderxu pdunhw/ wrs ohiw wkh surgxfwlrq ixqfwlrq/ wrs uljkw d 78 judsk wudqvihuulqj rxwsxw wkurxjk wr wkh erwwrp uljkw/ zklfk lv wkh vxsso| fxuyh ehwzhhq wkh sulfh ohyho dqg rxwsxw1 Wkh surgxfwlrq ixqfwlrq/ S I / zklfk fdq eh wkrxjkw ri dv wkh rswlpdo ehkdylrxu ri wkh dyhudjh up wlphv wkh qxpehu ri upv/ wdnhv fdslwdo dv jlyhq dqg khqfh vkrzv glplqlvklqj uhwxuqv ri rxwsxw +T, wr lqfuhdv0 lqj oderxu lqsxw +O,1 Iurp lw lv ghulyhg wkh ghpdqg iru oderxu/ GG/ zkhuh +iru wkh dyhudjh up, wkh uhdo zdjh htxdov wkh pdujlqdo surgxfw ri oderxu/ ru htxlydohqwo| wkh sulfh @ pdujlqdo frvw/ wkh uvw0rughu frq0 glwlrq ri d surw pd{lpxp1 Wkh vxsso| ri oderxu/ VV/ lv vkrzq zlwk d dwwlvk vorsh/ lqglfdwlqj wkdw wkh vxevwlwxwlrq hhfw ri ulvlqj uhdo zdjhv/ Z S / lv vxevwdqwldoo| odujhu wkdq wkh lqfrph hhfw> wklv frxog frph derxw ehfdxvh hlwkhu zrunhuv vxevwlwxwh hruw dfurvv wlph ru xqhpsor|phqw ehqhwv duh jhqhurxv dqg orqj0odvwlqj +dv glvfxvvhg ehorz/ uhvshfwlyho|/ lq Fkdswhuv dqg wkh uhdvrq lv wkdw dv sulfhv ulvh shrsoh gr qrw uhdolvh wkdw doo sulfhv duh ulvlqj +lq dwlrq,1 Zrunhuv lq sduwlfxodu gr qrw uhdolvh wklv dqg lq wklv gldjudp duh dvvxphg wr eh vorz wkhuhiruh lq udlvlqj wkhlu zdjhv1 Khqfh dv sulfhv ulvh zdjhv odj ehklqg dqg uhdo zdjhv idoo wr wkh uljkw dorqj wkh ghpdqg iru oderxu fxuyh +wklv Pdfurhfrqrplfv= d Vxfflqfw Lqwurgxfwlrq ) ƒ : / ' /RQJ5XQ $6 6 ' O / 6KRUW 5XQ Đ: ã ă â 3¹ $ 4 Iljxuh 414= Djjuhjdwh Vxsso| fdq eh wkrxjkw ri dv d uljkwzdug vkliw ri wkh oderxu vxsso| fxuyh,1 Wklv jhqhudwhv pruh hpsor|phqw dqg pruh rxwsxw +wklv lv ghyhorshg ixoo| lq Fkdswhu 6/ uvw vhfwlrq/ cWkh Qhz Fodvvlfdo Skloolsv Fxuyh*,1 Ghpdqg Zh vxssrvh iru vlpsolflw| dq hfrqrp| zkhuh wkhuh lv qr dowhuqdwlyh wr xvlqj fdvk iru sd|lqj zrunhuv dqg iru ex|lqj jrrgv1 Lq wklv cfdvk0lq0 dgydqfh* wudqvdfwlrqv whfkqrorj|/ zh dovr dvvxph wkhuh lv d sd|phqw shulrg/ rqh prqwk iru h{dpsoh1 Wkhq wkh hfrqrp| cwxuqv prqh| ryhu* dv looxvwudwhg lq Iljxuh 415,1 Dw wkh hqg ri wkh prqwk zrunhuv duh sdlg dqg vshqg wkhlu fdvk wkurxjk wkh vxffhhglqj prqwk1 Dv fdvk pryhv iurp zrunhuv wr upv wkh wrwdo kroglqj ri lw uhpdlqv frqvwdqw  wklv lv wkh ghpdqg iru fdvk iru wudqvdfwlrqv1 Li zh phdvxuh prqh| rxwsxw/ S T/ lq d |hdu ru dw dq dqqxdo udwh/ lw iroorzv wkdw fdvk uhtxluhg lv htxdo wr rqh prqwk*v rxwsxw dqg vr wkh ghpdqg iru prqh|/ P G @ +4@45,  S T +zkhuh 4245 lv wkh iudfwlrq ri rxwsxw uhtxluhg dv prqh|/ N, ru htxlydohqwo| P G  45 @ S T Prghov ri wkh Hfrqrp| +zkhuh 45 lv wkh cyhorflw|*/ Y / ri prqh|,> uhvshfwlyho| wkh Fdpeulgjh +XN, dqg wkh txdqwlw| wkhru| zd|v ri zulwlqj prqh| ghpdqg1 &DVK &DVK'HPDQGE\KRXVHKROGV &DVK'HPDQGE\ILUPV 7RWDO'HPDQGIRU &DVK+RXVHKROGV DQG)LUPV HWF   7LPHPRQWKV Iljxuh 415= Wudqvdfwlrqv Ghpdqg iru Prqh| Ehjlq e| vxssrvlqj wkdw wkh prqh| vxsso| P htxdov P G / wkdw lv wkhuh lv htxloleulxp lq wkh prqh| pdunhw1 Xqghu rxu dvvxpswlrqv wklv dovr lpsolhv wkdw lqfrph htxdov vshqglqj +dv lq jxuh 415,1 Qrz vxssrvh wkh jryhuqphqw lqfuhdvhv wkh prqh| vxsso| e| 43 shu fhqw +e| sulqwlqj pruh, dqg jlyhv wkh h{wud prqh| wr zrunhuv dw wkh hqg ri wkh prqwk1 Dw h{lvwlqj S T+3, wkh zrunhuv sodq qrupdo vshqglqj ri S T+3, zklfk lv wkhlu qrupdo lqfrph dqg upv qhhg wr sd| rxw rqo| ST+3, lq zdjhv> vr qhlwkhu zrunhuv ru upv qhhg wr krog rq wr wkh h{wud prqh| iru ixwxuh prqwkv1 Wkh zrunhuv zloo wkhuhiruh vshqg wkh h{wud prqh| rq ex|lqj jrrgv/ gulylqj xs S T dorqj wkh DV fxuyh1 Dw wklv srlqw S T+4, lv kljkhu> upv krog pruh prqh| wr sd| iru h{wud zrun1 Exw zkhq P uhwxuqv wr frqvxphuv/ vwloo P V A P G dqg djdlq DG A S T+4,1 Khqfh wkh surfhvv zloo uhshdw lwvhoi dqg S T zloo ulvh djdlq1 Rqo| zkhq S T kdv ulvhq vx!flhqwo| iru P V @ P G @ SYT zloo zh kdyh DG @ S T1 Wklv lv zkhuh S T @ PY Wklv lv wkh cdjjuhjdwh ghpdqg* frqvlvwhqw zlwk wkh vwrfn ri prqh| +Iljxuh 416,1 Lq fodvvlfdo wklqnlqj sulfhv dqg zdjhv pryh udslgo| wr uhvwruh wkh hfrqrp| wr lwv srwhqwldo/ T > khqfh lqwhuhvw udwhv pryh wr hqvxuh wkdw vdylqj htxdov lqyhvwphqw  iru h{dpsoh/ li dw T shrsoh ghflgh wr vdyh pruh wklv zrxog phdq pruh ixqgv zrxog eh rhuhg wr lqyhvwruv lq sodqw dqg pdfklqhu| dqg lqwhuhvw udwhv +wkh frvw ri wkhvh cordqdeoh ixqgv*, zrxog idoo xqwlo wkh pdunhw iru vdylqjv htxloleudwhg zlwk lqyhvwphqwv1 Vr zh fdq vd| wkdw lqwhuhvw udwhv duh qrw dhfwhg e| wkh ghpdqg iru ru Pdfurhfrqrplfv= d Vxfflqfw Lqwurgxfwlrq /RJ3 $ : $' /RJ09 '09 Whvwlqj wkh Udwlrqdo H{shfwdwlrqv K|srwkhvlv zkhuh  @ +4.U, 69< dqg Hw Pw.4 @ Pw lpso|lqj wkdw Pw lv d pduwlqjdoh surfhvv1 Ohdglqj + H^w xw m Lw ` @ 3> H^xw Pw m Lw ` @ 3> H^xw yw m Lw ` @ 3> H^yw Pw m Lw ` @ 3= Wkhvh dvvxpswlrqv hvwdeolvk wkh lqghshqghqfh ri doo vwrfkdvwlf ydul0 deohv lq doo ohdgv dqg odjv1 Qr uhvwulfwlqj dvvxpswlrqv duh uhtxluhg frq0 fhuqlqj wkh qdwxuh ri wkh udqgrp yduldeoh xw = Vxssrvh xw @ 4> ghqh d udqgrp yduldeoh kw wkdw lv qrupdoo| glv0 wulexwhg zlwk phdq  dqg yduldqfh 5k Zh fdq wkhq h{sorlw wkh surshuw| ri frqglwlrqdo orj qrupdolw| dqg ghqh w iru dq| duelwudu| frqvwdqw  dv  w @ h ehfdxvh   # # kM   # k 5 5k Hhkw @ Hhkw.4 @ h +