Macroeconomics I Doepke

MACROECONOMICS

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Matthias Doepke
University of Chicago

Andreas Lehnert
Board of Governors of the Federal Reserve System

Andrew W. Sellgren
George Mason University

A This book was typeset in Palatino and Computer Modern using L TEX.

Draft of 1 September 1999. c Chapters 5, 8, 9, and 11 Copyright ­ 1999, by Matthias Doepke. cChapters 10, 12, 13, 14, 17, 18, and 19 Copyright ­ 1999, by Andreas Lehnert. c Chapters 1, 2, 3, 4, 6, and 15 Copyright ­ 1999, by Andrew W. Sellgren. All rights reserved. No part of this work may be reproduced in any form by any electronic or mechanical means (including, but not limited to, photocopying, recording, or information storage and retrieval) without permission in writing from thecopyright owner. The authors permit faculty, students, and staff of the University of Chicago to copy and distribute any part of this work for use in classes taught at the University of Chicago.

Preface
We have designed this book to be a supplement to Robert J. Barro’s Macroeconomics, which is the textbook that is used in introductory macroeconomics courses at the University of Chicago. Inteaching these courses, we have found that Barro’s treatment of the subject does not make use of the mathematical skills of our students. In particular, Barro relies almost exclusively on economic intuition and graphs to elucidate his subject. Since our students are familiar with calculus, we are able to work out formal models. This almost always allows greater concreteness and concision. We haveattempted to align our chapters with those in Barro’s textbook. Sometimes our chapters present mathematical versions of the models that Barro introduces in his corresponding chapters (as in Chapters 2 and 19). Other times, our chapters contain material that extends his work (as in Chapters 5 and 17). Throughout, we have tried to add value to the treatment in Barro’s book and to minimize redundancy. Forexample, we have nothing to add to Barro’s Chapters 7, 16, and 20, so we have not covered those chapters. Three chapters deviate from this plan. Chapter 1 develops the mathematics of interest rates and growth rates; Barro does not cover these topics, but they are behind the scenes in his Chapter 1 and throughout his book. Chapter 10, which covers unemployment, is completely unrelated to Barro’sChapter 10. It is intended as a companion to the book Job Creation and Destruction by Davis, Haltiwanger, and Schuh. Chapter 18 covers the relationship between the government budget constraint and inflation along the lines of the “Unpleasant Monetarist Arithmetic” of Sargent and Wallace. Although Barro has a sidebar on this topic in his Chapter 14, we feel that it is important enough to merit achapter of its own. We chose Chapter 18 since it is a natural point between fiscal policy (Chapters 12, 13, and 14) and monetary policy (Chapter 19). Barro’s Chapter 18 is a review of the empirical evidence on the effect of monetary shocks on the real economy, and is well worth covering. There are exercises after each chapter, and we have provided complete solutions at the end of this book. We believethat exercises are essential for students to learn this material. They give students a sense of what they ought to know, since these exercises have been drawn from several years of exams. Also, we often use exercises to introduce extensions to the material in the text. We have attempted to estimate the difficulty of these exercises, labeling them as “Easy,” “Moderate”, or “Hard”. An exercise with a“Hard” rating may require a lot of algebra, or it may use unfamiliar concepts. Most other questions are rated

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Preface

as “Moderate”, unless they have one-line solutions, in which case we usually rated them as “Easy”. We teach this material in two ten-week courses. In the first course we cover Chapters 1, 2, 3, 6, 4, 5, 7, 8, 9, and 11, in that order. This allows us to keep together...