Macroeconomic Theory

Macroeconomic Theory

Macroeconomic Theory
A Dynamic General Equilibrium Approach

Michael Wickens

Princeton University Press Princeton and Oxford

Copyright © 2008 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 3 Market Place, Woodstock, Oxfordshire OX20 1SY AllRights Reserved ? A catalogue record for this book is available from the British Library This book has been composed in Times and typeset by T&T Productions Ltd, London Printed on acid-free paper press.princeton.edu Printed in the United States of America 10 9 8 7 6 5 4 3 2 1
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Contents

Preface 1 Introduction 1.1 Dynamic General Equilibrium versus Traditional Macroeconomics 1.2Traditional Macroeconomics 1.3 Dynamic General Equilibrium Macroeconomics 1.4 This Book The Centralized Economy 2.1 Introduction 2.2 The Basic Dynamic General Equilibrium Closed Economy 2.3 Golden Rule Solution 2.3.1 The Steady State 2.3.2 The Dynamics of the Golden Rule 2.4 Optimal Solution 2.4.1 Derivation of the Fundamental Euler Equation 2.4.2 Interpretation of the Euler Equation 2.4.3 IntertemporalProduction Possibility Frontier 2.4.4 Graphical Representation of the Solution 2.4.5 Static Equilibrium Solution 2.4.6 Dynamics of the Optimal Solution 2.4.7 Algebraic Analysis of the Saddlepath Dynamics 2.5 Real-Business-Cycle Dynamics 2.5.1 The Business Cycle 2.5.2 Permanent Technology Shocks 2.5.3 Temporary Technology Shocks 2.5.4 The Stability and Dynamics of the Golden Rule Revisited 2.6 Laborin the Basic Model 2.7 Investment 2.7.1 q-Theory 2.7.2 Time to Build 2.8 Conclusions Economic Growth 3.1 Introduction 3.2 Modeling Economic Growth 3.3 The Solow–Swan Model of Growth 3.3.1 Theory 3.3.2 Growth and Economic Development

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3.3.3 Balanced Growth The Theory ofOptimal Growth 3.4.1 Theory 3.4.2 Additional Remarks on Optimal Growth Endogenous Growth 3.5.1 The AK Model of Endogenous Growth 3.5.2 The Human Capital Model of Endogenous Growth Conclusions

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3.5

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TheDecentralized Economy 4.1 Introduction 4.2 Consumption 4.2.1 The Consumption Decision 4.2.2 The Intertemporal Budget Constraint 4.2.3 Interpreting the Euler Equation 4.2.4 The Consumption Function 4.2.5 Permanent and Temporary Shocks 4.3 Savings 4.4 Life-Cycle Theory 4.4.1 Implications of Life-Cycle Theory 4.4.2 Model of Perpetual Youth 4.5 Nondurable and Durable Consumption 4.6 Labor Supply 4.7 Firms 4.7.1Labor Demand without Adjustment Costs 4.7.2 Labor Demand with Adjustment Costs 4.8 General Equilibrium in a Decentralized Economy 4.8.1 Consolidating the Household and Firm Budget Constraints 4.8.2 The Labor Market 4.8.3 The Goods Market 4.9 Comparison with the Centralized Model 4.10 Conclusions Government: Expenditures and Public Finances 5.1 Introduction 5.2 The Government Budget Constraint 5.2.1The Nominal Government Budget Constraint 5.2.2 The Real Government Budget Constraint 5.2.3 An Alternative Representation of the GBC 5.3 Financing Government Expenditures 5.3.1 Tax Finance 5.3.2 Bond Finance 5.3.3 Intertemporal Fiscal Policy 5.3.4 The Ricardian Equivalence Theorem 5.4 The Sustainability of the Fiscal Stance 5.4.1 Case 1: [(1 + π )(1 + γ)]/(1 + R) > 1 (Stable Case) 5.4.2Implications 5.4.3 Case 2: 0 < [(1 + π )(1 + γ)]/(1 + R) < 1 (Unstable Case) 5.4.4 Implications 5.4.5 The Optimal Level of Debt 5.5 The Stability and Growth Pact 5.6 The Fiscal Theory of the Price Level 5.7 Optimizing Public Finances

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5.7.1 Optimal Government Expenditures 5.7.2 Optimal Tax Rates Conclusions

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