Über die Autorin bzw. den Autor

Michael Wickens is professor of economics at the University of York and at Cardiff Business School. He is the coeditor of Handbook of Applied Econometrics and was managing editor of the Economic Journal from 1996 to 2004. He is specialist adviser to the House of Lords on macroeconomics and a member of the Shadow Monetary Policy Committee.

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Praise for the previous edition: "This is an innovative graduate textbook that develops much of modern macroeconomics in the framework of stochastic general equilibrium models. The book is especially good for its integration of macro and finance."--Christopher Pissarides, London School of Economics and Political Science

Praise for the previous edition: "There are very few good textbooks on the dynamic general equilibrium approach to macroeconomics;Macroeconomic Theory fills a big void and provides a comprehensive and integrated approach to the subject that covers both real and monetary models. Professor Wickens develops a series of topics, beginning with real models of the economy and proceeding through growth, fiscal policy, financial models, and the modern approach to monetary economies. Each topic begins with theoretical background and proceeds to practical applications. The level is appropriate for master's or advanced undergraduate students and is a welcome addition to the field that is likely to be widely adopted."--Roger E. A. Farmer, University of California, Los Angeles

Praise for the previous edition: "A most welcome graduate (or advanced undergraduate) textbook in macroeconomics. The book is well written and the text is effectively organized and progresses in a natural and easy-to-follow way. The text offers a mathematical approach that is easily accessible to the students. The technical level is sufficiently detailed to allow students to understand the role of the underlying assumptions and how the models work, and yet it avoids unnecessary technicalities and sidetracks. As an extra bonus, it offers a treatment of financial aspects which are often neglected in macro textbooks."--Torben M. Andersen, University of Aarhus, Denmark

Praise for the previous edition: "Wickens's text provides a tremendous introduction to modern macroeconomics. The coverage of material is thorough. The writing is clear and lively. The mathematics is sufficiently detailed without being overly technical, and the mathematical appendix helps keep the text largely self-contained. Intuition behind key results is provided beautifully throughout. Having worked through the text, students will be well-equipped for a journey toward the macroeconomics frontier."--David N. DeJong, University of Pittsburgh

Praise for the previous edition: "This is a first-rate book that definitely helps fill a surprising lacuna in graduate macro teaching."--Andrew Scott, London Business School

Praise for the previous edition: "This book provides an integrated, self-contained, and accessible exposition of modern macroeconomic theory. Particular strengths include coverage of macroeconomic approaches to asset pricing and the analysis of monetary and fiscal policies. It is an excellent textbook for students in masters and PhD courses and an excellent reference for professional economists."--Philip Lane, Trinity College Dublin

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Macroeconomic Theory

Princeton University Press

Contents

Preface....................................................................................xiii1 Introduction.............................................................................12 The Centralized Economy..................................................................153 Economic Growth..........................................................................434 The Decentralized Economy................................................................605 Government: Expenditures and Public Finances.............................................906 Fiscal Policy: Further Issues............................................................1297 The Open Economy.........................................................................1538 The Monetary Economy.....................................................................1859 Imperfectly Flexible Prices..............................................................21610 Unemployment............................................................................24311 Asset Pricing and Macroeconomics........................................................26712 Financial Markets.......................................................................29813 Nominal Exchange Rates..................................................................34814 Monetary Policy.........................................................................40215 Banks, Financial Intermediation, and Unconventional Monetary Policy.....................46416 Real Business Cycles, DSGE Models, and Economic Fluctuations............................50117 Mathematical Appendix...................................................................538References.................................................................................575Index......................................................................................589

Chapter One

1.1 Dynamic General Equilibrium versus Traditional Macroeconomics

Modern macroeconomics seeks to explain the aggregate economy using theories based on strong microeconomic foundations. This is in contrast to the traditional Keynesian approach to macroeconomics, which is based on ad hoc theorizing about the relations between macroeconomic aggregates. In modern macroeconomics the economy is portrayed as a dynamic stochastic general equilibrium (DSGE) system that reflects the collective decisions of rational individuals over a range of variables that relate to both the present and the future. These individual decisions are then coordinated through markets to produce the macroeconomy. The economy is viewed as being in continuous equilibrium in the sense that, given the information available, people make decisions that appear to be optimal for them, and so do not knowingly make persistent mistakes. This is also the sense in which behavior is said to be rational. Errors, when they occur, are attributed to information gaps, such as unanticipated shocks to the economy.

A distinction commonly drawn is between short-run and long-run equilibria. The economy is assumed to be always in short-run equilibrium. The long run, or the steady state, is a mathematical property of the macroeconomic model that describes its path when all past shocks have fully worked through the system. This can be either a static equilibrium, in which all variables are constant, or, more generally, a growth equilibrium, in which in the absence of shocks, there is no tendency for the economy to depart from a given path, usually one in which the main macroeconomic aggregates grow at the same rate. It is not, therefore, the economy that is assumed to be in long-run equilibrium, but the macroeconomic model. The (short-run or long-run) equilibrium is described as general because all variables are assumed to be simultaneously in equilibrium, not just some of them, or a particular market, which is a situation known as partial equilibrium.

Individual decisions are assumed to be based on maximizing the discounted sum of current and future expected welfare subject to preferences and four constraints: budget or resource constraints, endowments, the available technology, and information. A central issue in DSGE macroeconomics is the intertemporal nature of decisions: whether to consume today or save today in order to consume in the future. This entails being able to transfer today's income for future use, or future income for today's use. These transfers may be achieved by holding financial assets or by borrowing against future income. The different decisions are then reconciled through the economy-wide market system, and by market prices (including asset prices). Much of the focus of modern macroeconomics, therefore, is on the individual's responses to shocks and how these are likely to affect multiple markets simultaneously, both in the present and in the future. For example, the business cycle is attributed to such shocks.

Shocks are often treated as random variables unpredictable from the past. Consequently, dynamic general equilibrium (DGE) models are often referred to as dynamic stochastic general equilibrium models. As it is often simpler to carry out our analysis without explicitly including the stochastic features of a model, we will occasionally refer to DGE rather than DSGE models until we formally introduce stochastic elements in our discussion of the theory of finance in chapter 11.

Three main types of decision are taken by economic agents. They relate to goods and services, labor, and assets: physical assets (the capital stock, durables, housing, etc.) or financial assets (money, bonds, and equity)—each has its own economy-wide market. It is convenient to consider the decisions of individuals according to whether they are acting, in economic terms, as a household, a firm, or a government. Broadly, the decisions of the household relate to consumption, labor supply, and asset holdings. The firm determines the supply of goods and services, labor demand, investment, productive and financial capital, and the use of profits. Government determines its expenditures, taxation, transfers, base money, and the issuance of public debt. Financial firms, including the banks, coordinate the borrowing and savings decisions of these three agents via the financial markets.

A convenient starting point for the study of DSGE macroeconomic models is a small general equilibrium model, but one that includes the main macroeconomic variables of interest. It is based on a single individual who produces a good that can either be consumed or invested to increase future output and consumption. It is commonly known either as the Ramsey (1928) model or as the representative-agent model. This is a surprisingly useful characterization of the economy as it permits the analysis of a number of its key features—consumption and saving, saving and investment, investment and dividend payments, technological progress, the intertemporal nature of decisions, the nature of economic equilibrium, the short-run and long-run behavior of the economy (the business cycle and economic growth), and how prices, such as real wages and real interest rates, are determined—but without having to introduce them explicitly.

The basic Ramsey model can be roughly interpreted as that of a closed economy, without a market structure, in which the decisions are coordinated by a central planner. A first step toward greater realism is to allow decisions to be decentralized. This requires us to add markets—which act to coordinate decisions, and thereby enable us to abandon the device of the central planner—and financial assets. Subsequent steps are to include a government, and hence fiscal policy, to introduce money, and hence a distinction between real and nominal variables, and to allow a foreign dimension (the current account, the balance of payments, and real and nominal exchange rates). At each stage the economy is analyzed as a general equilibrium system and the significance for the economy of each added feature can be studied. Because it highlights individual behavior, one of the main attractions of this approach is that it provides a suitable framework for analyzing economic policy through respecting the "deep structural" parameters of the economy, which are not usually changed by policy—unless, of course, they are policy parameters that are changed. This too is in contrast to traditional macroeconomic models, like the Keynesian model, which are not specified in terms of the deep structural parameters but by coefficients that may be changed by policy in a manner that is often unspecified or unknown.

1.2 Traditional Macroeconomics

Views on how best to analyze macroeconomic variables such as aggregate consumption, total output, and inflation have changed much in the last twenty-five years. Under the influence of Keynesian macroeconomics, the emphasis was on the short-run behavior of the economy, why the economy seemed to persist in a state of disequilibrium, and how best to bring it back to equilibrium, i.e., how to stabilize the economy. In studying these issues, it was common for each macroeconomic variable to be modeled one at a time in separate equations; only then were they combined to form a model of the whole economy. The Brookings macroeconometric model was constructed in exactly this way (Duesenberry 1965): in the first stage individual aggregate variables were allocated to separate researchers and then, in the second stage, their equations were collected together to form the complete macroeconometric model. As a result, macroeconomics tended to focus on the short-run behavior of the economy and did so using a partial-equilibrium approach that led to a compartmentalization of thought in which it was difficult to acquire an overall view of how the system as a whole was likely to behave in response, for example, to a change in an exogenous variable, such as a policy instrument, or to a shock. Consequently, it was sometimes difficult to take into account the wider and longer-term effects of policy—policies that may even have been designed to combat the shock. There was, therefore, a tendency for policy to be too narrowly conceived and analyzed.

The study of macroeconomics was prompted in large part by the Great Depression—the worldwide recession of the 1930s. One of Keynes's original objectives in The General Theory (Keynes 1936) was to understand how such sustained periods of high unemployment could occur. From the beginning, therefore, interest was directed not so much to how the economic system behaved in long-run equilibrium, but to why it seemed to be misbehaving in the short run by generating periods of apparent disequilibrium—in particular, departures from full employment—and to what, if anything, could be done about this. Until the last few years macroeconomic theory (and especially macroeconomic textbooks) has focused mainly on constructing models to explain this so-called disequilibrium behavior in the economy with a view to formulating appropriate stabilization policies to return the economy to equilibrium. The grounds for stabilization policy are that the economic system departs from equilibrium and, left to itself, would not return to equilibrium, or would do so too slowly. The aim of the policy intervention is to restore equilibrium, or to return the economy to equilibrium (or close to equilibrium) more quickly. This disequilibrium approach to macroeconomics tends to focus on individual markets and not the system as a whole. It also emphasizes the demand side of the economy. The outcome was a piecemeal, partial-equilibrium approach to macroeconomics. A corollary of the emphasis on disequilibrium was that equilibrium came to be regarded as a special, and less important, case.

1.3 Dynamic General Equilibrium Macroeconomics

The traditional approach to macroeconomics may be contrasted with the conception of DSGE macroeconomics that economic agents are continuously reoptimizing, subject to constraints, with the result that the macroeconomy is always in some form of equilibrium, whether short run or long run. According to this view, the short-run equilibrium of the economy may differ from its long-run equilibrium but, if stable, the short-run equilibrium will be changing through time and will over time approach the long-run equilibrium; but the only sense in which the economy can be in disequilibrium at any point in time is through basing decisions on the wrong information. From this perspective, even the view sometimes expressed that disequilibrium is a special case of DSGE macroeconomics is misleading. DSGE models assume that ex ante the economy is always in equilibrium.

Although for most economies macroeconomics has retained a focus on shortrun behavior and stabilization, inspection of the path followed by gross domestic product (GDP) shows that the dominant feature is the growth in the trend of potential output; the loss of output due to recessions is almost trivial by comparison. This suggests that it is far more important to raise the rate of growth of potential output through supply-side policies than to move the economy back toward the trend path of potential output by demand-side stabilization policies.

The origins of DSGE macroeconomics lie in the work of Lucas (1975), Kydland and Prescott (1982), and Long and Plosser (1983) on real business cycles. Their aim was to explain the dynamic behavior of the economy (notably the autocovariances of real output and the covariances of output with other aggregate macroeconomic time series) based on a competitive rational-expectations equilibrium model that took its inspiration from models of economic growth. The initial focus was on the role of technology shocks in generating the business cycle. The model used by Kydland and Prescott was, in essence, the model of Ramsey; that of Lucas included, in addition, government expenditures and money. Subsequent work extended the model in various ways in order to examine the effects of other types of shocks. We consider the principal results of this research in chapter 16. These issues are not, however, the sole concern of DSGE macroeconomics, or of this book.

A frequent motivation for constructing macroeconomic models, and one of the first questions usually asked of a model, is what it implies for economic policy. (A recent discussion of the usefulness of DSGE models in formulating policy is Chari and Kehoe (2006).) Nonetheless, it is important to realize that the aim of macroeconomics is not just to study policy issues. There are prior questions that should be asked, such as how the economy might behave if it were in equilibrium, and how it responds to changes in exogenous variables and to shocks. Finding the answers to these questions is a sufficient reason to study macroeconomics. Although it is common to ask what the policy implications of a macroeconomic theory are, with the implicit assumption that we are forever seeking to interfere in the economy, it is not always necessary to search for policies that alter the equilibrium solution, especially if we are unclear what the broader consequences might be. Arguably, simply trying to understand how the economy behaves is sufficient justification.

Much of our analysis will be on considering what sort of factors might disturb an economy's equilibrium, and how the economy responds to these. They may be changes in exogenous variables or shocks. They may be permanent or temporary, anticipated or unanticipated, real or nominal, demand or supply, domestic or foreign, and the response of the economy may be different in each case. The conclusions we reach are often very different from those based on traditional macroeconomic models. Shocks may be serially uncorrelated, but the intrinsic dynamic structure of the economy may result in them having persistent effects on macroeconomic variables. This is the cause of short-term fluctuations in the economy, and hence the basis of business-cycle theory.

DSGE models are forward looking and hence intertemporal. Current decisions are affected by expectations about the future. As a result, we use intertemporal dynamic optimization, in which people are treated as if they rationally process current information about the future when making their decisions. There is a premium on obtaining the correct information and on deciding how best to use it. These concerns are linked to the concept of rationality—another key feature of DSGE macroeconomics. The willingness of macroeconomists to make the assumption of rationality rapidly divided professional opinion into two camps. Traditional macroeconomics was based on the assumption of myopic decision making in which mistakes, even when realized, were often persisted in. The central idea behind rational expectations is that people do not make persistent mistakes once they are identified. This does not necessarily imply, as is often assumed, that people have more or less complete knowledge, for the mistakes are largely the result of unanticipated information gaps or shocks. It is sufficient to suppose that mistakes are not repeated. As forward-looking decisions must be based on expectations of the future, they may be incorrect; decisions that seem correct ex ante may not therefore be correct ex post. As previously noted, only as a result of this type of mistake might it be appropriate to think of the economy as being in disequilibrium.

Recent research has suggested that a policy of intervention by the government tends to be most successful when the government has an informational advantage over the private sector. If the private sector is able to fully anticipate the intervention, then the policy may be less successful. This is mostly true when the intervention involves private rather than public goods. As the private sector would substitute public for private goods, in effect, households would be paying for these goods from taxes instead of after-tax income. In contrast, the provision of public goods leads to a net increase in output as total private benefits exceed total private costs. These arguments about government expenditures apply more generally, of course, and will be developed further below.

(Continues...)

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