Heijdra Foundations of Modern Macroeconomics (Oxford, 2002)

35

36

38

39 nd capital 45

aint 49 51 53 54

57

59

60

60

60

67

67

71

71

73

78

79

80

80

80

85

98

103

104

106

106

107

108

	Detailed Contents
5.1.3 Notional behaviour of firms	110
5.1.4 Walrasian equilibrium	111
5.1.5 Effective demands and supplies of households	113
5.1.6 Effective demands and supplies of firms	115
5.1.7 The full model	116
5.1.8 The effectiveness of fiscal and monetary policy	118
5.1.9 Wage and price dynamics	121
5.2 Rationing in Small Open Economies	122
5.3 Intertemporal Spillovers	124
5.3.1 Walrasian expectations	126
5.3.2 Bootstrap effects	127
5.3.3 Rational constraint expectations	130
5.4 Punchlines	132
Further Reading	133

6. The Government Budget Deficit	134
6.1 Ricardian Equivalence	134
6.1.1 A simple model	135
6.1.2 Distorting taxes	139
6.1.3 Borrowing restrictions	144
6.1.4 Finite lives	145
6.1.5 Some further reasons for Ricardian non-equivalence	151
6.1.6 Empirical evidence	152
6.2 The Theory of Government Debt Creation	152
6.2.1 A simple model of tax smoothing	152
6.3 Punchlines	157
Further Reading	158

7. A Closer Look at the Labour Market	159
7.1 Some Stylized Facts	159
7.2 The Standard Macroeconomic Labour Market Theory	166
7.2.1 Flexible wages and clearing markets	166
7.2.2 The effects of taxation	171
7.3 Real Wage Rigidity	176
7.3.1 Implicit contracts	177
7.3.2 Efficiency wages	178

Detailed Contents

7.4 Punchlines	184
Further Reading	186

8. Trade Unions and the Labour Market		187
8.1	Some Models of Trade Union Behaviour	187
	8.1.1 The monopoly model of the trade union	190
	8.1.2 The "right to manage" model	192
	8.1.3 The efficient bargaining model	194
	8.1.4 Trade unions in a two-sector model	197
8.2	Corporatism	198
8.3 Fiscal Increasing Returns		199
8.4	Hysteresis and the Persistence of Unemployment	202
8.5 Applications of Trade Union Models		205
	8.5.1 The effects of taxation	205
	8.5.2 Unions and investment	206
8.6 Punchlines		210
Further Reading		212

9. Search in the Labour Market	213
9.1 Search in the Labour Market	213
9.1.1 A simple model	214
9.1.2 Market equilibrium	223
9.1.3 Comparative static effects	226
9.2 Applications of Search Models	227
9.2.1 The effects of taxation	227
9.2.2 Deposits on workers?	229
9.2.3 Search unemployment, loss of skills, and persistence	231
9.3 Punchlines	232
Further Reading	233
Appendix	233

10. Macroeconomic Policy, Credibility, and Politics	236
10.1 Dynamic Inconsistency	236
10.1.1 A classic tale	236
10.1.2 A neoclassical tale	237
10.1.3 Reputation as an enforcement mechanism	242

10.2The Vo

10.3Dynarn

10.3.31

10.4Punch Further Read

Appendix

11.The Open Ec

11.1The Int

11.1.15

11.1.21

11.1.3(

11.1.4)

11.2Trans: -

11.2.21

11.2.31

11.2.41

11.3Forwark

11.3.11

11.4Pun.....

Further

12.Money

12.1Functio

12.2Moc:

12.2:2

12.3Money

12.3.21

xiv

184

186

187

187

190

192

194

197

198

199

202

205

205

206

210

212

213

213

214

223

226

227

227

229

231

232

233

233

236

236

236

237

242

	Detailed Contents
10.2 The Voting Approach to Optimal Inflation		247
10.3 Dynamic Consistency and Capital Taxation		249
10.3.1 The first-best optimum		250
10.3.2 The second-best problem		253
10.3.3 Dynamic inconsistency of the optimal tax plan		255
10.4 Punchlines		257
Further Reading	n	258
Appendix		259
11. The Open Economy		261
11.1 The International Sector in the IS-LM Model		261
11.1.1 Some bookkeeping		261
11.1.2 The modified IS-LM model for a small open economy		264
11.1.3 Capital mobility and economic policy		265
11.1.4 Aggregate supply considerations		275
11.2 Transmission of Shocks in a Two-country World		282
11.2.1 Nominal wage rigidity in both countries		284
11.2.2 Real wage rigidity in both countries		287
11.2.3 Real wage rigidity in Europe and nominal wage rigidity in the
United States		288
11.2.4 International policy coordination		291
11.3 Forward-looking Behaviour in International Financial Markets		296
11.3.1 The Dombusch model		297
11.4 Punchlines		308
Further Reading	°	310
12. Money		311
12.1 Functions of Money		311
12.2 Modelling Money as a Medium of Exchange		314
12.2.1 Setting the stage		314
12.2.2 Shopping costs		316
12.2.3 Money in the utility function		319
12.3 Money as a Store of Value		321
12.3.1 Overlapping-generations model of money		323
12.3.2 Uncertainty and the demand for money		327

xv

Detailed Contents

12.4 The Optimal Quantity of Money	338
12.4.1 A basic general equilibrium model	340
12.4.2 The satiation result	342
12.4.3 Critiques of the full liquidity rule	345
12.4.4 An infinite horizon model	348
12.5 Punchlines	355
Further Reading	356
Appendix	356
13. New Keynesian Economics	359
13.1 Reconstructing the "Keynesian" Multiplier	359
13.1.1 A static model with monopolistic competition	360
13.1.2 The short-run balanced-budget multiplier	367
13.1.3 The short-run multiplier in isolation	369
13.1.4 The "long-run" multiplier	369
13.1.5 Welfare effects	374
13.2 Monopolistic Competition and Money	377
13.3 Sticky Prices and the Non-neutrality of Money	379
13.3.1 Menu costs, real rigidity, and monetary neutrality	380
13.3.2 Quadratic price adjustment costs	397
13.3.3 Staggered price contracts	398
13.4 Punchlines	401
Further Reading	402
14. Theories of Economic Growth	404
14.1 Stylized Facts of Economic Growth	404
14.2 The Solow—Swan Model	405
14.2.1 No technological progress	406
14.2.2 Technological progress	408
14.3 Properties of the Solow—Swan Model	410
14.3.1 The golden rule of capital accumulation	410
14.3.2 Transitional dynamics and convergence	413
14.3.3 The speed of adjustment	416
14.3.4 Human capital to the rescue	417
14.4 Macroeconomic Applications	419
14.4.1 Fiscal policy in the Solow model	419

14.5The 14.5. 14.5.. 14.5.: 14.5.- 14.5.: 14.5 14.5./

-

14.6Ent: , 14.6.1 14.6._ 14.6.3

14.7Punct

Further R.

Appendix

15.Real Buser) ,

15.1Introc

15.2Exterr

15.2.1

15.2.2

15.2.3

15.3The L

15.4Fiscal

15.4.1

15.4.2

15.5The Li 15.5.1 15.5.2 15.5.3 15.5.4

15.6Punct

Further Rea

Appendix

xvi

338

340

342

345

348

355

356

356

359

359

360

367

369

369

374

377

379 lit 380 397 398

401

402

404

404

405

406

408

410

410

413

416

417

419

419

Detailed Contents
14.5 The Ramsey Model	422
14.5.1 The representative consumer	423
14.5.2 The representative firm	426
14.5.3 The phase diagram	427
14.5.4 Efficiency properties of the Ramsey model	429
14.5.5 Transitional dynamics and convergence in the Ramsey model	430
14.5.6 An open-economy Ramsey model	431
14.5.7 Fiscal policy in the Ramsey model	440
14.5.8 Overlapping generations of infinitely lived dynasties	443
14.6 Endogenous Growth	448
14.6.1 "Capital-fundamentalist" models	449
14.6.2 Human capital formation	456
14.6.3 Endogenous technology	461
14.7 Punchlines	473
Further Reading	475
Appendix	475
15. Real Business Cycles	477
15.1 Introduction	477
15.2 Extending the Ramsey Model	478
15.2.1 Households	478
15.2.2 Firms	480
15.2.3 Equilibrium	481
15.3 The Unit-elastic Model	481
15.4 Fiscal Policy	483
15.4.1 Permanent fiscal policy	484
15.4.2 Temporary fiscal policy	496
15.5 The Lucas Research Programme	502
15.5.1 The unit-elastic RBC model	504
15.5.2 Impulse-response functions	511
15.5.3 Correlations	522
15.5.4 Extending the model	524
15.6 Punchlines	526
Further Reading	529
Appendix	530

xvii

Detailed Contents
16. Intergenerational Economics, I	540
16.1 Introduction	540
16.2 The Blanchard—Yaari Model of Overlapping Generations	540
16.2.1 Yaari's lessons	540
16.2.2 Turning lessons into a workhorse	545
16.3 Applications of the Basic Model	554
16.3.1 The effects of fiscal policy	554
16.3.2 The non-neutrality of government debt	555
16.4 Extensions	556
16.4.1 Endogenous labour supply	556
16.4.2 Age-dependent productivity	567
16.4.3 The open economy	571
16.5 Punchlines	581
Further Reading	583
Appendix	583
17. Intergenerational Economics, II	589
17.1 The Diamond—Samuelson Model	589
17.1.1 Households	590
17.1.2 Firms	591
17.1.3 Market equilibrium	592
17.1.4 Dynamics and stability	593
17.1.5 Efficiency	595
17.2 Applications of the Basic Model	596
17.2.1 Pensions	597
17.2.2 PAYG pensions and endogenous retirement	609
17.2.3 The macroeconomic effects of ageing	618
17.3 Extensions	621
17.3.1 Human capital accumulation	621
17.3.2 Public investment	632
17.3.3 Intergenerational accounting	642
17.4 Punchlines	648
Further reading	650

Epilogue

Chano,

Threal

Views

Mathematic;

A.1 Introch

A.2 Matrix A A.2.1 ( A.2.2 A.2.3 T

A.2.4 S.

A.2.5 C

A.2.6 C

A.2.7 L

A.3 Implicit I

A.3.1

A.3.2

A.3.3

A.4 Static 0

A.4.1 L

A.4.2 E.4

A.4.3 I.

A.4.4 Li

A.5 Single DA,

A.5.1

A.5.2 1-,

A.5.3 Li

A.5.4 L

A.6 Systems

A.6.1 11

A.6.2 S

A.6.3 ,.S)

A.6.4 H.

A.6.5 1,

A.7 Differei..

A.7.1 ft

A.7.2 T1

xviii

	540
	540
tions	540
-,
	540
	545
	554
	554
	555
	556
	556
	567
	571
	581
	583
	583

589

589

590

591

592

593

595

596

597

609

618

621

621

632

642

648

650

	Detailed Contents
Epilogue	652
Changes	652
Threads	654
Views	656

Mathematical Appendix	658
A.1 Introduction	658
A.2 Matrix Algebra	658
A.2.1 General	658
A.2.2 Addition, subtraction, multiplication	659
A.2.3 Transposition	660
A.2.4 Square matrices	660
A.2.5 Cramer's Rule	663
A.2.6 Characteristic roots and vectors	664
A.2.7 Literature	666
A.3 Implicit Function Theorem	667
A.3.1 Single equation	667
A.3.2 System of equations	667
A.3.3 Literature	669
A.4 Static Optimization	669
A.4.1 Unconstrained optimization	669
A.4.2 Equality constraints	671
A.4.3 Inequality constraints	672
A.4.4 Literature	675
A.5 Single Differential Equations	675
A.5.1 First-order (constant coefficients)	675
A.5.2 First-order (variable coefficients)	677
A.5.3 Leibnitz's rule	678
A.5.4 Literature	678
A.6 Systems of Differential Equations	678
A.6.1 The Laplace transform	678
A.6.2 Simple applications	683
A.6.3 Systems of differential equations	684
A.6.4 Hysteretic models	690
A.6.5 Literature	694
A.7 Difference Equations	695
A.7.1 Basic methods	695
A.7.2 The z-transform	696

xix

Detailed Contents

A.7.3	Simple application	698
A.7.4	The saddle-path model	699
A.7.5	Literature	700
A.8 Dynamic Optimization		700
A.8.1	Unconstrained	700
A.8.2	(In)equality constraints	702
A.8.3	Second-order conditions	702
A.8.4	Literature	703
Bibliography		704
Index		735

1.1Short-run p

1.2The dem,1,,

1.3The consul]

1.4The suit

1.5Aggregate s

1.6Aggreg,: s wage

1.7The

1.8Derivati,

1.9Monetary a

1.10Moneta a

1.11Monetary a synthesis ir

1.12The Lati- (

2.1Fiscal polio

2.2Stability an

2.3Adjustmelii

2.4Comparat

2.5The effect c

2.6Capital acct fiscal poll,.

2.7The effects

2.8Fiscal poli.

2.9Long-run financing a

3.1Monetary r

3.2Expectatioz

3.3The nor:

3.4Actual ai,d

3.5Actual and

3.6Wage se:

3.7The optima

4.1Investment

xx

698

699

700

700

700

702

702

703

704

735

List of Figures

1.1	Short-run profit maximization	3
1.2 The demand for labour		4
1.3	The consumption-leisure choice	6
1.4	The supply of labour	7
1.5	Aggregate supply and expectations	9

1.6Aggregate supply with downward nominal

	wage rigidity	12
1.7	The liquidity preference function	15
1.8	Derivation of the LM curve	16
1.9	Monetary and fiscal policy in the classical model	19
1.10 Monetary and fiscal policy in the Keynesian model		20
1.11 Monetary and fiscal policy in the neo-Keynesian
	synthesis model	22
1.12 The Laffer curve		25
2.1	Fiscal policy under adaptive expectations	33
2.2	Stability and adaptive expectations	35
2.3	Adjustment costs of investment	40
2.4	Comparative static effects in the IS-LM model	47
2.5	The effect on capital of a rise in public spending	48

2.6Capital accumulation and the Keynesian effects of

	fiscal policy	49
2.7	The effects of fiscal policy under money finance	53
2.8	Fiscal policy under (stable) bond financing	55

2.9Long-run effect of fiscal policy under different

	financing modes	56
3.1	Monetary policy under adaptive expectations	61
3.2 Expectational errors under adaptive expectations		62
3.3	The normal distribution	64
3.4	Actual and expected price under REH	66
3.5	Actual and expected price under AEH	66
3.6 Wage setting with single-period contracts		71
3.7	The optimal contract length	76
4.1	Investment with constant real wages	87

List of Figures

4.2	Derivation89of the saddle path		a
			7.10 Efficie:
4.3	An unanticipated permanent increase in the		7.11 The rein,
	investment subsidy	90	8.1 The iso-i
4.4	An unanticipated permanent increase in the	91	8.2 Indiffti.
	rate of interest		8.3 Wage set
4.5 An anticipated permanent increase in the rate of interest		92	8.4 Wage s
4.6	Investment with full employment in the labour market	94	8.5 Wages al
4.7	An anticipated abolition of the investment subsidy	94	8.6 Unemplc
4.8	A temporary increase in the investment subsidy	96	8.7 Unemplc
4.9	A fall in the tax on labour income: investment and	99	8.8 Fiscal int
	employment effects		9.1 Search ec
4.10 The short-run and long-run labour market effects		99	9.2 The effec
4.11 Anticipated fiscal policy		103	9.3 The effec
5.1	The minimum transaction rule	108	9.4 The t
5.2	The Walrasian equilibrium and the effects of fiscal policy	112	9.5 The effec
5.3	Effective equilibrium loci and the three regimes	116	10.1 Cons.
5.4	The Keynesian unemployment equilibrium and		10.2 Temptatli
	fiscal policy	118	10.3 The frequ
5.5	The repressed inflation equilibrium and fiscal policy	119	paraiLL
5.6	Wage and price dynamics and stability	122	11.1 The de(,:
5.7	Rationing in a simple model of the small open economy	123	paynk :it
5.8	Notional and effective equilibria with	126	11.2 Monetary
	Walrasian expectations		fixed ex
5.9	Effective equilibria with expectations of future	128	11.3 Mont
	Keynesian or classical unemployment		and fixed
6.1 Ricardian equivalence experiment		139	11.4 Montl....
6.2 Income, substitution, and human wealth effects		144	exchangt
6.3	Liquidity restrictions and the Ricardian experiment	145	11.5 Fiscal pc
6.4	Overlapping generations in a three-period economy	146	flexible t
-6.5 Optimal taxation		155	11.6 Foreign
6.6	Optimal taxation and tax smoothing	156	mot
7.1 Unemployment in the European Community and			11.7 Monetan
	the United States	160	and flexil
7.2 Unemployment in Japan and Sweden		160	11.8 Aggre6,a,
7.3 Unemployment in the United Kingdom and			11.9 Fiscal poi
	the Netherlands	161	both cou
7.4 Unemployment in the United Kingdom, 1855-2000		162	11.10 Monetan
7.5 Unemployment in the United States, 1890-2000		162	both cot:
7.6 The markets for skilled and unskilled labour		169	11.11 Fiscal poi
7.7 The effects of taxation when wages are flexible		175	11.12 Fiscal pc:
7.8 The effects of taxation with a fixed consumer wage		176
7.9 Labour demand and supply and the macroeconomic		177	11.13 Monetan
	wage equation