The basic tools for analyzing macroeconomic fluctuations and policies, applied to concrete issues and presented within an integrated New Keynesian framework.

This textbook presents the basic tools for analyzing macroeconomic fluctuations and policies and applies them to contemporary issues. It employs a unified New Keynesian framework for understanding business cycles, major crises, and macroeconomic policies, introducing students to the approach most often used in academic macroeconomic analysis and by central banks and international institutions. The book addresses such topics as how recessions and crises spread; what instruments central banks and governments have to stimulate activity when private demand is weak; and what “unconventional” macroeconomic policies might work when conventional monetary policy loses its effectiveness (as has happened in many countries in the aftermath of the Great Recession.).

The text introduces the foundations of modern business cycle theory through the notions of aggregate demand and aggregate supply, and then applies the theory to the study of regular business-cycle fluctuations in output, inflation, and employment. It considers conventional monetary and fiscal policies aimed at stabilizing the business cycle, and examines unconventional macroeconomic policies, including forward guidance and quantitative easing, in situations of “liquidity trap”—deep crises in which conventional policies are either ineffective or have very different effects than in normal time.

This book is the first to use the New Keynesian framework at the advanced undergraduate level, connecting undergraduate learning not only with the more advanced tools taught at the graduate level but also with the large body of policy-oriented research in academic journals. End-of-chapter problems help students master the materials presented.

Edouard Challe is Professor of Economics at Ecole Polytechnique and Director of Research at CNRS (the French National Center for Scientific Research).

Preface ix
Chapter 1 Introduction: From Business-Cycle Measurement to Macroeconomic Theory 1
1.1 The Gross Domestic Product and Its Breakdown 2
1.2 Measuring Business-Cycle Fluctuations 5
1.3 Business Cycle Theory 11
Part I Foundations: Aggregate Demand and Supply 17
Chapter 2 Aggregate Demand 19
2.1 The Real Interest Rates and the Macroeconomic Equilibrium 20
2.2 Private Consumption 22
2.3 Investment 32
2.4 Net Exports 34
2.5 Aggregation of Expenditures 42
2.6 Monetary Policy and Aggregate Demand 45
2.7 Exercises 48
2.8 Appendix: The Log-Linear IS Curve 50
Chapter 3 Aggregate Supply 51
3.1 Firm Behavior 53
3.2 Labor Market Equilibrium 58
3.3 The Natural Equilibrium 61
3.4 Equilibrium with Nominal Price Rigidities 63
3.5 Empirical Evaluation of the AS Curve 71
3.6 Alternative Formulations of the AS Curve 73
3.7 Exercises 79
3.8 Appendix: Optimal Labor Supply 85
Part II Business Cycles 87
Chapter 4 AS-AD Equilibrium and the Propagation of Macroeconomic Shocks 89
4.1 Macroeconomic Equilibrium 90
4.2 Effect of an Aggregate Demand Shock 93
4.3 Effect of an Aggregate Supply Shock 98
4.4 Nominal Rigidities and the Nature of Business-Cycle Fluctuations 101
4.5 Exercises 104
Chapter 5 Unemployment Fluctuations 109
5.1 The Dynamics of Unemployment and Worker Flows: Empirical Aspects 111
5.2 Search, Matching, and Equilibrium Unemployment 118
5.3 Macroeconomic Equilibrium 130
5.4 Exercises 134
Part III Conventional Macroeconomic Policies 141
Chapter 6 Monetary Policy 143
6.1 Monetary Policy Implementation 145
6.2 Optimal Monetary Policy 158
6.3 Expectations and the Credibility and Effectiveness of Monetary Policy 178
6.4 Exercises 198
Chapter 7 Fiscal Policy 203
7.1 Ricardian Equivalence 205
7.2 Fiscal Policy in General Equilibrium 216
7.3 The Government-Spending Multiplier 229
7.4 The Tax Multipliers 235
7.5 Exercises 242
Part IV The Liquidity Trap and Unconventional Policies 247
Chapter 8 The Liquidity Trap 249
8.1 The Financial Crisis and Aggregate Demand 250
8.2 The Zero Lower Bound on the Short-Term Nominal Interest Rate 257
8.3 The Liquidity Trap Paradoxes 268
8.4 Exercises 274 Chapter
9 Unconventional Monetary Policies 277
9.1 Forward Guidance 278
9.2 Large-Scale Asset Purchases 288
9.3 Iconoclastic Monetary Policies 298
9.4 Exercises 304
Chapter 10 Fiscal Policy and Structural Reforms in a Liquidity Trap 307
10.1 The General-Equilibrium AS-AD Model at the Zero Lower Bound 308
10.2 Fiscal Policy in a Liquidity Trap 311
10.3 Structural Reforms in a Liquidity Trap 323
10.4 Exercises 326
10.5 Appendix: Derivation of the General-Equilibrium AS-AD Model in a Liquidity Trap 328
References 331
Index 337