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MACROECONOMICS
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An economist must be “mathematician, historian, statesman, philosopher,
in some degree . . . as aloof and incorruptible as an artist, yet sometimes
as near the earth as a politician.” So remarked John Maynard Keynes, the
great British economist who, as much as anyone, could be called the father of
macroeconomics. No single statement summarizes better what it means to be an
economist.
As Keynes’s assessment suggests, students who aim to learn economics need to
draw on many disparate talents. The job of helping students find and develop
these talents falls to instructors and textbook authors. When writing this textbook
for intermediate-level courses in macroeconomics, my goal was to make
macroeconomics understandable, relevant, and (believe it or not) fun. Those of
us who have chosen to be professional macroeconomists have done so because
we are fascinated by the field. More important, we believe that the study of
macroeconomics can illuminate much about the world and that the lessons
learned, if properly applied, can make the world a better place. I hope this book
conveys not only our profession’s accumulated wisdom but also its enthusiasm
and sense of purpose.
This Book’s Approach
Macroeconomists share a common body of knowledge, but they do not all have
the same perspective on how that knowledge is best taught. Let me begin this
new edition by recapping four of my objectives, which together define this
book’s approach to the field.
First, I try to offer a balance between short-run and long-run issues in macroeconomics.
All economists agree that public policies and other events influence
the economy over different time horizons. We live in our own short run, but we
also live in the long run that our parents bequeathed us. As a result, courses in
macroeconomics need to cover both short-run topics, such as the business cycle
and stabilization policy, and long-run topics, such as economic growth, the natural
rate of unemployment, persistent inflation, and the effects of government
debt. Neither time horizon trumps the other.
Second, I integrate the insights of Keynesian and classical theories. Although
Keynes’s General Theory provides the foundation for much of our current understanding
of economic fluctuations, it is important to remember that classical economics
provides the right answers to many fundamental questions. In this book
I incorporate many of the contributions of the classical economists before
Keynes and the new classical economists of the past three decades. Substantial
coverage is given, for example, to the loanable-funds theory of the interest rate,
the quantity theory of money, and the problem of time inconsistency. At the same time, I recognize that many of the ideas of Keynes and the new Keynesians are
necessary for understanding economic fluctuations. Substantial coverage is given
also to the IS–LM model of aggregate demand, the short-run tradeoff between
inflation and unemployment, and modern models of business cycle dynamics.
Third, I present macroeconomics using a variety of simple models. Instead of
pretending that there is one model that is complete enough to explain all facets
of the economy, I encourage students to learn how to use and compare a set of
prominent models. This approach has the pedagogical value that each model can
be kept relatively simple and presented within one or two chapters. More important,
this approach asks students to think like economists, who always keep various
models in mind when analyzing economic events or public policies.
Fourth, I emphasize that macroeconomics is an empirical discipline, motivated
and guided by a wide array of experience. This book contains numerous Case
Studies that use macroeconomic theory to shed light on real-world data or
events. To highlight the broad applicability of the basic theory, I have drawn the
Case Studies both from current issues facing the world’s economies and from
dramatic historical episodes. The Case Studies analyze the policies of Alexander
Hamilton, Henry Ford, George Bush (both of them!), and Barack Obama. They
teach the reader how to apply economic principles to issues from fourteenthcentury
Europe, the island of Yap, the land of Oz, and today’s newspaper.
What’s New in the Seventh Edition?
This edition includes some of the most significant changes since the book was
first published in 1992. The revision reflects new events in the economy as well
as new research about the best way to understand macroeconomic developments.
By far the biggest change is the addition of Chapter 14, “A Dynamic Model
of Aggregate Demand and Aggregate Supply.” In recent years, academic
research and policy analyses of short-run economic fluctuations have increasingly
centered on dynamic, stochastic, general equilibrium models with nominal
rigidities. These models are too complex to present in full detail to most
undergraduate students, but the essential insights of these models can be taught
with both simplicity and rigor. That is the purpose of this new chapter. It
builds on ideas the students have seen before, both in previous chapters and in
previous courses, and it exposes students to ideas that are prominent at the
research and policy frontier.
The other chapters in the book have been updated to incorporate the latest
data and recent events, including recent turmoil in financial markets and the
economy more broadly. Here are some of the noteworthy additions:
➤ Chapter 3 includes a new FYI box called “The Financial System:
Markets, Intermediaries, and the Crisis of 2008 and 2009.”
➤ Chapter 4 has a new Case Study about the recent hyperinflation in
Zimbabwe.
➤ Chapter 9 includes a new Case Study called “A Monetary Lesson From
French History.”
➤ Chapter 9 includes a new FYI box on the monetary theory of David Hume.
➤ Chapter 10 has a new Case Study on the economic stimulus plan
proposed and signed by President Barack Obama.
➤ Chapter 11 includes a new Case Study called “The Financial Crisis and
Economic Downturn of 2008 and 2009.”
➤ Chapter 13’s appendix includes a new schematic diagram illustrating how
various macroeconomic models are related. (Thanks to Robert Martel of
the University of Connecticut for suggesting it.)
➤ Chapter 16 has a new Case Study on how the U.S. Treasury and
Congressional Budget Office accounted for spending on the Troubled
Asset Relief Program (TARP) in 2008 and 2009.
➤ Chapter 18 includes a new discussion of the recent boom and bust in the
housing market.
➤ Chapter 19 has a new section on bank capital, leverage, and capital
requirements.
As always, all the changes that I made, and the many others that I considered,
were evaluated keeping in mind the benefits of brevity. From my own experience
as a student, I know that long books are less likely to be read. My goal in
this book is to offer the clearest, most up-to-date, most accessible course in
macroeconomics in the fewest words possible.
The Arrangement of Topics
My strategy for teaching macroeconomics is first to examine the long run when
prices are flexible and then to examine the short run when prices are sticky. This
approach has several advantages. First, because the classical dichotomy permits
the separation of real and monetary issues, the long-run material is easier for students
to understand. Second, when students begin studying short-run fluctuations,
they understand fully the long-run equilibrium around which the
economy is fluctuating. Third, beginning with market-clearing models makes
clearer the link between macroeconomics and microeconomics. Fourth, students
learn first the material that is less controversial among macroeconomists. For all
these reasons, the strategy of beginning with long-run classical models simplifies
the teaching of macroeconomics.
Let’s now move from strategy to tactics. What follows is a whirlwind tour of
the book.
Part One, Introduction
The introductory material in Part One is brief so that students can get to the
core topics quickly. Chapter l discusses the broad questions that macroeconomists
address and the economist’s approach of building models to explain the world.
Chapter 2 introduces the key data of macroeconomics, emphasizing gross
domestic product, the consumer price index, and the unemployment rate.
Part Two, Classical Theory: The Economy in the Long Run
Part Two examines the long run over which prices are flexible. Chapter 3 presents
the basic classical model of national income. In this model, the factors of
production and the production technology determine the level of income, and
the marginal products of the factors determine its distribution to households. In
addition, the model shows how fiscal policy influences the allocation of the
economy’s resources among consumption, investment, and government purchases,
and it highlights how the real interest rate equilibrates the supply and
demand for goods and services.
Money and the price level are introduced in Chapter 4. Because prices are
assumed to be fully flexible, the chapter presents the prominent ideas of classical
monetary theory: the quantity theory of money, the inflation tax, the Fisher
effect, the social costs of inflation, and the causes and costs of hyperinflation.
The study of open-economy macroeconomics begins in Chapter 5. Maintaining
the assumption of full employment, this chapter presents models
to explain the trade balance and the exchange rate. Various policy issues
are addressed: the relationship between the budget deficit and the trade
deficit, the macroeconomic impact of protectionist trade policies, and the
effect of monetary policy on the value of a currency in the market for foreign
exchange.
Chapter 6 relaxes the assumption of full employment by discussing the
dynamics of the labor market and the natural rate of unemployment. It examines
various causes of unemployment, including job search, minimum-wage laws,
union power, and efficiency wages. It also presents some important facts about
patterns of unemployment.
Part Three, Growth Theory: The Economy in the Very Long Run
Part Three makes the classical analysis of the economy dynamic by developing
the tools of modern growth theory. Chapter 7 introduces the Solow growth
model as a description of how the economy evolves over time. This chapter
emphasizes the roles of capital accumulation and population growth. Chapter 8
then adds technological progress to the Solow model. It uses the model to discuss
growth experiences around the world as well as public policies that influence
the level and growth of the standard of living. Finally, Chapter 8 introduces
students to the modern theories of endogenous growth.
Part Four, Business Cycle Theory: The Economy in the Short Run
Part Four examines the short run when prices are sticky. It begins in Chapter 9
by examining some of the key facts that describe short-run fluctuations in economic
activity. The chapter then introduces the model of aggregate supply and
aggregate demand as well as the role of stabilization policy. Subsequent chapters
refine the ideas introduced in this chapter.
Chapters 10 and 11 look more closely at aggregate demand. Chapter 10
presents the Keynesian cross and the theory of liquidity preference and uses
these models as building blocks for developing the IS–LM model. Chapter 11 uses the IS–LM model to explain economic fluctuations and the aggregate
demand curve. It concludes with an extended case study of the Great Depression.
The study of short-run fluctuations continues in Chapter 12, which focuses on
aggregate demand in an open economy. This chapter presents the Mundell–Fleming
model and shows how monetary and fiscal policies affect the economy under floating
and fixed exchange-rate systems. It also discusses the debate over whether
exchange rates should be floating or fixed.
Chapter 13 looks more closely at aggregate supply. It examines various
approaches to explaining the short-run aggregate supply curve and discusses the
short-run tradeoff between inflation and unemployment.
Chapter 14 develops a dynamic model of aggregate demand and aggregate
supply. It builds on ideas that students have already encountered and uses those
ideas as stepping-stones to take the student close to the frontier of knowledge
concerning short-run economic fluctuations.
Part Five, Macroeconomic Policy Debates
Once the student has command of standard long-run and short-run models of
the economy, the book uses these models as the foundation for discussing some
of the key debates over economic policy. Chapter 15 considers the debate over
how policymakers should respond to short-run economic fluctuations. It emphasizes
two broad questions: Should monetary and fiscal policy be active or passive?
Should policy be conducted by rule or by discretion? The chapter presents arguments
on both sides of these questions.
Chapter 16 focuses on the various debates over government debt and budget
deficits. It gives some sense about the magnitude of government indebtedness,
discusses why measuring budget deficits is not always straightforward, recaps the
traditional view of the effects of government debt, presents Ricardian equivalence
as an alternative view, and discusses various other perspectives on government
debt. As in the previous chapter, students are not handed conclusions but
are given the tools to evaluate the alternative viewpoints on their own.
Part Six, More on the Microeconomics Behind Macroeconomics
After developing theories to explain the economy in the long run and in the
short run and then applying those theories to macroeconomic policy debates,
the book turns to several topics that refine our understanding of the economy.
The last three chapters analyze more fully the microeconomics behind macroeconomics.
These chapters can be presented at the end of a course, or they can
be covered earlier, depending on an instructor’s preferences.
Chapter 17 presents the various theories of consumer behavior, including the
Keynesian consumption function, Fisher’s model of intertemporal choice,
Modigliani’s life-cycle hypothesis, Friedman’s permanent-income hypothesis, Hall’s
random-walk hypothesis, and Laibson’s model of instant gratification. Chapter 18
examines the theory behind the investment function. Chapter 19 provides additional
material on the money market, including the role of the banking system in
determining the money supply and the Baumol–Tobin model of money demand.
Epilogue
The book ends with a brief epilogue that reviews the broad lessons about which
most macroeconomists agree and discusses some of the most important open
questions. Regardless of which chapters an instructor chooses to cover, this capstone
chapter can be used to remind students how the many models and themes
of macroeconomics relate to one another. Here and throughout the book, I
emphasize that despite the disagreements among macroeconomists, there is much
that we know about how the economy works.
Alternative Routes Through the Text
I have organized the material in the way that I prefer to teach intermediate-level
macroeconomics, but I understand that other instructors have different preferences.
I tried to keep this in mind as I wrote the book so that it would offer a
degree of flexibility. Here are a few ways that instructors might consider re -
arranging the material:
➤ Some instructors are eager to cover short-run economic fluctuations. For
such a course, I recommend covering Chapters 1 through 4 so students
are grounded in the basics of classical theory and then jumping to
Chapters 9, 10, 11, 13, and 14 to cover the model of aggregate demand
and aggregate supply.
➤ Some instructors are eager to cover long-run economic growth. These
instructors can cover Chapters 7 and 8 immediately after Chapter 3.
➤ An instructor who wants to defer (or even skip) open-economy macroeconomics
can put off Chapters 5 and 12 without loss of continuity.
➤ An instructor who wants to emphasize the microeconomic foundations
of macroeconomics can teach Chapters 17, 18, and 19 early in the course,
such as immediately after Chapter 6 (or even earlier).
Experience with previous editions suggests this text complements well a variety
of approaches to the field.
Learning Tools
I am pleased that students have found the previous editions of this book userfriendly.
I have tried to make this seventh edition even more so.
Case Studies
Economics comes to life when it is applied to understanding actual events.
Therefore, the numerous Case Studies (many new or revised in this edition) are
an important learning tool, integrated closely with the theoretical material presented
in each chapter. The frequency with which these Case Studies occur
ensures that a student does not have to grapple with an overdose of theory before
seeing the theory applied. Students report that the Case Studies are their favorite
part of the book.
FYI Boxes
These boxes present ancillary material “for your information.” I use these boxes
to clarify difficult concepts, to provide additional information about the tools of
economics, and to show how economics relates to our daily lives. Several are new
or revised in this edition.
Graphs
Understanding graphical analysis is a key part of learning macroeconomics, and
I have worked hard to make the figures easy to follow. I often use comment boxes
within figures that describe briefly and draw attention to the important points
that the figures illustrate. They should help students both learn and review the
material.
Mathematical Notes
I use occasional mathematical footnotes to keep more difficult material out of
the body of the text. These notes make an argument more rigorous or present a
proof of a mathematical result. They can easily be skipped by those students who
have not been introduced to the necessary mathematical tools.
Chapter Summaries
Every chapter ends with a brief, nontechnical summary of its major lessons. Students
can use the summaries to place the material in perspective and to review
for exams.
Key Concepts
Learning the language of a field is a major part of any course. Within the chapter,
each key concept is in boldface when it is introduced. At the end of the
chapter, the key concepts are listed for review.
Questions for Review
After studying a chapter, students can immediately test their understanding of its
basic lessons by answering the Questions for Review.
Problems and Applications
Every chapter includes Problems and Applications designed for homework
assignments. Some of these are numerical applications of the theory in the chapter.
Others encourage the student to go beyond the material in the chapter by
addressing new issues that are closely related to the chapter topics.
Chapter Appendices
Several chapters include appendices that offer additional material, sometimes at
a higher level of mathematical sophistication. These are designed so that instructors
can cover certain topics in greater depth if they wish. The appendices can
be skipped altogether without loss of continuity. Glossary
To help students become familiar with the language of macroeconomics, a glossary
of more than 250 terms is provided at the back of the book.
Translations
The English-language version of this book has been used in dozens of countries.
To make the book more accessible for students around the world, editions
are (or will soon be) available in 15 other languages: Armenian, Chinese,
French, German, Greek, Hungarian, Indonesian, Italian, Japanese, Korean, Portuguese,
Romanian, Russian, Spanish, and Ukrainian. In addition, a Canadian
adaptation coauthored with William Scarth (McMaster University) and a
European adaptation coauthored with Mark Taylor (University of Warwick)
are available. Instructors who would like information about these versions of
the book should contact Worth Publishers.
Acknowledgments
Since I started writing the first edition of this book two decades ago, I have benefited
from the input of many reviewers and colleagues in the economics profession.
Now that the book is in its seventh edition, these individuals are too
numerous to list in their entirety. However, I continue to be grateful for their
willingness to have given up their scarce time to help me improve the economics
and pedagogy of this text. Their advice has made this book a better teaching
tool for hundreds of thousands of students around the world.
I would like to mention those instructors whose recent input shaped this new
edition:
Jinhui Bai
Georgetown University
Joydeep Bhattacharya
Iowa State University
Ronald Cronovich
Carthage College
Massimiliano De Santis
Dartmouth College
John Driscoll
Federal Reserve Board
James Fackler
University of Kentucky
Chris Foote
Federal Reserve Bank of
Boston
David R. Hakes
University of Northern Iowa
Christopher House
University of Michigan
Nancy Jianakoplos
Colorado State University
George Karras
University of Illinois at Chicago
Roger Kaufman
Smith College
Manfred W. Keil
Claremont McKenna
College
John Leahy
New York University
Christopher Magee
Bucknell University
Robert Martel
University of Connecticut
Meghan Millea
Mississippi State University
Robert Murphy
Boston College
John Neri
University of Maryland
Christina Peters
University of Colorado
at Boulder
Jeffrey Reynolds
Northern Illinois University
David Romer
University of California
at Berkeley
Brian Rosario
American River College
Naveen Sarna
Northern Virginia
Community College
Mark Siegler
California State University
at Sacramento
David Spencer
Brigham Young University
Henry S. Terrell
University of Maryland
Nora Underwood
University of Central Florida
Jaejoon Woo
DePaul University
Bill Yang
Georgia Southern University
Noam Yuchtman
Harvard University
In addition, I am grateful to Stacy Carlson, a student at Harvard, who helped
me update the data, refine my prose, and proofread the entire book.
The people at Worth Publishers have continued to be congenial and dedicated.
I would like to thank Catherine Woods, Senior Publisher; Craig Bleyer,
Senior Publisher; Sarah Dorger, Acquisitions Editor; Scott Guile, Senior Marketing
Manager; Marie McHale, Senior Development Editor; Paul Shensa, Consulting
Editor; Tom Acox, Media and Supplements Assistant Editor; Lorraine
Klimowich, Associate Media and Supplements Editor; Steven Rigolosi, Director
of Market Research and Development; Dana Kasowitz, Project Editor; Tracey
Kuehn, Associate Managing Editor; Barbara Seixas, Production Manager; Barbara
Reingold, Art Director; Vicki Tomaselli, Design Manager; Kevin Kall, Layout
Designer; Karen Osborne, Copyeditor; Laura McGinn, Supplements Editor; and
Stacey Alexander, Supplements Manager.
Many other people made valuable contributions as well. Most important, Jane
Tufts, freelance developmental editor, worked her magic on this book once
again, confirming that she’s the best in the business. Alexandra Nickerson did a
great job preparing the index. Deborah Mankiw, my wife and in-house editor,
continued to be the first reader of new material, providing the right mix of criticism
and encouragement.
Finally, I would like to thank my three children, Catherine, Nicholas, and
Peter. They helped immensely with this revision—both by providing a pleasant
distraction and by reminding me that textbooks are written for the next
generation.
N.GREGORY MANKIW - Personal Name
SEVENTH
978-1-4292-1887-0
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