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2 nd Edition
Macroeconomics
Policy and Practice
Frederic S. Mishkin
Columbia University
Boston Columbus Indianapolis New York San Francisco Upper Saddle River
Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto
Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
Macroeconomics Matters: The Latest Economic Events and Policy Responses
APPLICATIONS apply the analysis POLICY AND PRACTICE MACROECONOMICS IN THE NEWS
in each chapter to explain important c examples boxes introduce relevant news
real-world situations. of policies and how they were articles and data from the daily
executed. press and explain how to read them.
Chapter 2 Measuring • Can GDP Buy Happiness? • Unemployment and Employment

Macroeconomic Data • Policy and Overstatements of • Interest Rates
the Cost of Living
Chapter 3 Aggregate • Why Are Some Countries Rich and

Production and Others Poor?
Productivity • Explaining Real Wage Growth
• Oil Shocks, Real Wages, and the
Stock Market
Chapter 4 Saving and • How the United States Became the • Government Policies to • Balance of Payments Accounts
Investment in Closed and Largest Net Debtor in the World Stimulate Saving
Open Economies cits • Crowding Out and the Debate
over the 2009 Fiscal Stimulus
Package
Chapter 5 Money and • Testing the Quantity Theory of Money • The Zimbabwean • The Monetary Aggregates
ation • Testing the Fisher Effect ation
Chapter 5 Appendix The • Quantitative Easing and the Money

Money Supply Process Supply 2007–2013
Chapter 6 The Sources • Evidence on Convergence, • China’s One-Child Policy

of Growth and the Solow 1960–2012 and Other Policies to Limit
Model • U.S. Growth Rates in the Population Growth
Postwar Period
Chapter 7 Drivers of • Does Population Growth Improve • Government Measures to

Growth: Technology, Living Standards? Increase Human Capital
Policy, and Institutions • The World Bank’s Doing
Business
• Does Foreign Aid Work?
Chapter 8 Business • Leading Economic Indicators

Cycles: An Introduction
Chapter 9 The IS Curve • The Vietnam War Buildup, • The Fiscal Stimulus Package
1964–1969 of 2009
Chapter 10 Monetary • Movements Along the MP

Policy and Aggregate Curve: The Rise in the Federal
Demand Funds Rate Target, 2004–2006
• Shifts in the MP Curve:
Autonomous Monetary Easing
at the Onset of the 2007–2009
Financial Crisis
Chapter 11 Aggregate • The Phillips Curve Tradeoff
Supply and the Phillips and Macroeconomic Policy in
Curve the 1960s
Chapter 12 The ation, 1980–1986

Aggregate Demand and • Negative Demand Shocks, 2001–
Supply Model 2004
• Negative Supply Shocks, 1973–1975
and 1978–1980
• Positive Supply Shocks, 1995–1999
• Negative Supply and Demand
Shocks and the 2007–2009 Financial
Crisis
• The United Kingdom and the
2007–2009 Financial Crisis
• China and the 2007–2009 Financial
Crisis
APPLICATIONS apply the analysis POLICY AND PRACTICE MACROECONOMICS IN THE NEWS
in each chapter to explain important c examples boxes introduce relevant news
real-world situations. of policies and how they were articles and data from the daily
executed. press and explain how to read them.
Chapter 13 ation • The Federal Reserve’s Use of the

Macroeconomic Policy and • Nonconventional Monetary Equilibrium Real Interest Rate, r*
Aggregate Demand and Policy and Quantitative Easing • The Activist/Nonactivist Debate
Supply Analysis Over the Obama Fiscal Stimulus
Package
• The Fed’s Use of the Taylor Rule
• Abenomics and the Shift in
Japanese Monetary Policy in 2013
Chapter 14 The Financial • The Tyranny of Collateral

System and Economic • Is China a Counter-Example
Growth to the Importance of Financial
Development to Economic Growth?
Chapter 15 Financial • The Mother of All Financial Crises: • Was the Fed to Blame for the
Crises and the Economy The Great Depression Housing Price Bubble?
• The Global Financial Crisis of • The Federal Reserve’s
2007–2009 Nonconventional Monetary
Policies and Quantitative Easing
During the Global Financial Crisis
• Japan’s Lost Decade, 1992–2002
• Debate Over Central Bank
Response to Bubbles
Chapter 16 Fiscal Policy • The Entitlements Debate: Social

and the Government Security and Medicare/Medicaid
Budget • The European Sovereign Debt Crisis
• Tax Smoothing
• The 2009 Debate Over Tax-Based
Versus Spending-Based Fiscal
Stimulus
• Two Expansionary Fiscal
Contractions: Denmark and Ireland
• The Debate Over Fiscal Austerity
in Europe
• The Bush Tax Cuts and Ricardian
Equivalence
Chapter 17 Exchange • The Global Financial Crisis and • Will the Euro Survive? • Foreign Exchange Rates
Rates and International the Dollar • The Collapse of the Argentine
Economic Policy • Why Are Exchange Rates So Currency Board
Volatile?
• How Did China Accumulate Over $3
Trillion of International Reserves?
Chapter 18 Consumption • Consumer Confidence and the • The 2008 Tax Rebate • The Consumer Confidence and
and Saving Business Cycle • Behavioral Policies to Increase Consumer Sentiment Indices
• Housing, the Stock Market, and the Saving
Collapse of Consumption in 2008
and 2009
Chapter 19 • Stock Market Crashes and • U.S. Government Policies and the
Investment Recessions Housing Market
Chapter 20 The Labor • Why Has Labor Force Participation • Unemployment Insurance and
Market, Employment, and of Women Increased? Unemployment
Unemployment • Why Are Income Inequality and • Minimum Wage Laws
Returns to Education Increasing?
• Why Are European Unemployment
Rates Generally Much Higher Than
U.S. Unemployment Rates?
Chapter 21 The Role • The Consumption Function • The Political Business Cycle and
of Expectations in • A Tale of Three Oil Price Shocks Richard Nixon
Macroeconomic Policy • The Demise of Monetary
Targeting in Switzerland
• Ben Bernanke and the Federal
Reserve Adoption of Inflation
Targeting
• The Appointment of Paul Volcker,
ation Hawk
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FRED® is a registered trademark and the FRED® logo and ST. LOUIS FED are trademarks of the Federal
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Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A. and
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Cataloging-in-Publication Data is on file at the Library of Congress
10 9 8 7 6 5 4 3 2 1
ISBN 10: 0-13-342431-6

ISBN 13: 978-0-13-342431-7
To My Mom
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Brief Contents
PART 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter 1 The Policy and Practice of Macroeconomics . . . . . . . . . . . 3
Chapter 2 Measuring Macroeconomic Data . . . . . . . . . . . . . . . . . . 19
PART 2 Macroeconomic Basics . . . . . . . . . . . . . . . . . . . . . . . . 48

Chapter 3 Aggregate Production and Productivity . . . . . . . . . . . . . 50
Chapter 4 Saving and Investment in Closed and Open Economies . . 73
Chapter 5 Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . 101
PART 3 Long-Run Economic Growth . . . . . . . . . . . . . . . . . . . 144

Chapter 6 The Sources of Growth and the Solow Model . . . . . . . . 146
Chapter 7 Drivers of Growth: Technology, Policy, and Institutions . 178
PART 4 Business Cycles: The Short Run . . . . . . . . . . . . . . . . 204

Chapter 8 Business Cycles: An Introduction . . . . . . . . . . . . . . . . 207
Chapter 9 The IS Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231
Chapter 10 Monetary Policy and Aggregate Demand . . . . . . . . . . 251
Chapter 11 Aggregate Supply and the Phillips Curve . . . . . . . . . . 281
Chapter 12 The Aggregate Demand and Supply Model . . . . . . . . . 299
Chapter 13 Macroeconomic Policy and Aggregate Demand
and Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327
PART 5 Finance and the Macroeconomy . . . . . . . . . . . . . . . . 370

Chapter 14 The Financial System and Economic Growth . . . . . . . 372
Chapter 15 Financial Crises and the Economy . . . . . . . . . . . . . . . 391
PART 6 Macroeconomic Policy . . . . . . . . . . . . . . . . . . . . . . . 425

Chapter 16 Fiscal Policy and the Government Budget . . . . . . . . . 427
Chapter 17 Exchange Rates and International Economic Policy . . . 450
PART 7 Microeconomic Foundations of Macroeconomics . . . . . 492

Chapter 18 Consumption and Saving . . . . . . . . . . . . . . . . . . . . . 494
Chapter 19 Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523
Chapter 20 The Labor Market, Employment,
and Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544
vii
viii brief Contents
PART 8 Modern Business Cycle Analysis

and Macroeconomic Policy . . . . . . . . . . . . . . . . . . . . 571
Chapter 21 The Role of Expectations in Macroeconomic Policy . . . 573
Chapter 22 Modern Business Cycle Theory . . . . . . . . . . . . . . . . . 597
Epilogue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619
Web Chapter Financial Crises in Emerging Market Economies
Go to the Companion Website, www.pearsonhighered.com/mishkin
Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxxi
PART 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter 1
The Policy and Practice of Macroeconomics . . . . . . . . . . . 3
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Practice of Macroeconomics . . . . . . . . . . . . . . . . . . . . 3
The Process: Developing Macroeconomic Models . . . . . . . . . . . . . . . . . . 3
The Purpose: Interpreting Macroeconomic Data . . . . . . . . . . . . . . . . . . . 5
Macroeconomic Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
How Can Poor Countries Get Rich? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Is Saving Too Low? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Do Government Budget Deficits Matter? . . . . . . . . . . . . . . . . . . . . . . . . 11
How Costly Is It to Reduce Inflation? . . . . . . . . . . . . . . . . . . . . . . . . . . 11
How Can We Make Financial Crises Less Likely? . . . . . . . . . . . . . . . . . . 12
How Active Should Stabilization Policy Be? . . . . . . . . . . . . . . . . . . . . . 12
Should Macroeconomic Policy Follow Rules? . . . . . . . . . . . . . . . . . . . . 13
Are Global Trade Imbalances a Danger? . . . . . . . . . . . . . . . . . . . . . . . . 13
How We Will Study Macroeconomics . . . . . . . . . . . . . . . . . 13
Emphasis on Policy and Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Data Analysis Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Chapter 2
Measuring Macroeconomic Data . . . . . . . . . . . . . . . . . . . . 19
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Measuring Economic Activity: National
Income Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Measuring GDP: The Production Approach . . . . . . . . . . . . 20
Market Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Final Goods and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Newly Produced Goods and Services . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Fixed Period of Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
POLICY AND PRACTICE: Can GDP Buy Happiness? . . . . . . . . . . . . . . . . 23
Stocks Versus Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Measuring GDP: The Expenditure Approach . . . . . . . . . . . 24
Consumption Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Government Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Meaning of the Word Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Net Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
ix
Changes in the Spending Components of GDP over Time . . . . . . . . . . . . 27
x Contents
Measuring GDP: The Income Approach . . . . . . . . . . . . . . . . 28

Categories of Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
An International Comparison of Expenditure Components . . . . . . . . . . . . 29
Income Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Real Versus Nominal GDP . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Nominal Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Real Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Chain-Weighted Measures of Real GDP . . . . . . . . . . . . . . . . . . . . . . . . 33
Measuring Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
GDP Deflator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
PCE Deflator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Consumer Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
POLICY AND PRACTICE: Policy and Overstatements
of the Cost of Living . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Percentage Change Method and the Inflation Rate . . . . . . . . . . . . . . . . 36
Measuring Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . 37
Macroeconomics in the News: Unemployment and Employment . . 39
Measuring Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . 40
Types of Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Macroeconomics in the News: Interest Rates . . . . . . . . . . . . . . . . 40
Real Versus Nominal Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
The Important Distinction Between Real and Nominal
Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
PART 2 Macroeconomic Basics . . . . . . . . . . . . . . . . . 48

Chapter 3
Aggregate Production and Productivity . . . . . . . . . . . . . 50
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Determinants of Aggregate Production . . . . . . . . . . . . . 50
Factors of Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Production Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Cobb-Douglas Production Function . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Application: Why Are Some Countries Rich and Others Poor? . . . . . . . 52
Cobb-Douglas Production Function Characteristics . . . . . . . . . . . . . . . . 54
Changes in the Production Function: Supply Shocks . . . . . . . . . . . . . . . 57
Determination of Factor Prices . . . . . . . . . . . . . . . . . . . . . 59
Demand for Capital and Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Supply of Capital and Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Factor Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Distribution of National Income . . . . . . . . . . . . . . . . . . . . 64
Application: Explaining Real Wage Growth . . . . . . . . . . . . . . . . . . . . 65
Application: Oil Shocks, Real Wages, and the Stock Market . . . . . . . . 66
Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Contents xi
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
Chapter 4
Saving and Investment in Closed and Open Economies . . 73
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Relationship Between Saving and Wealth . . . . . . . . . . . . . 73
Private Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Government Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
National Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
POLICY AND PRACTICE: Government Policies to Stimulate Saving . . . . . 76
Uses of Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
The Link Between Saving and Wealth . . . . . . . . . . . . . . . . . . . . . . . . . 78
Macroeconomics in the News: Balance of Payments Accounts . . . . 78
Application: How the United States Became the Largest Net
Debtor in the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Saving, Investment, and Goods Market Equilibrium
in a Closed Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Saving and Investment Equation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
Goods Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Response to Changes in Saving and Investment
in a Closed Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
Changes in Saving: Autonomous Consumption . . . . . . . . . . . . . . . . . . . 85
Changes in Saving: Effects of Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . 85
POLICY AND PRACTICE: Crowding Out and the Debate over
the 2009 Fiscal Stimulus Package . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
Changes in Autonomous Investment . . . . . . . . . . . . . . . . . . . . . . . . . . 88
Saving, Investment, and Goods Market Equilibrium
in an Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Perfect Capital Mobility and the Open Economy . . . . . . . . . . . . . . . . . . 89
Goods Market Equilibrium in an Open Economy . . . . . . . . . . . . . . . . . . 89
Saving, Investment, and the Trade Balance
in a Small Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Goods Market Equilibrium in a Small Open Economy . . . . . . . . . . . . . . . 90
Connection Between the World Economy and the Small
Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Response to Changes in Saving and Investment
in a Small Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Changes in Domestic Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Application: The Twin Deficits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
Changes in Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Large Versus Small Open Economies . . . . . . . . . . . . . . . . 95
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
xii Contents
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
Data Analysis Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Chapter 4 Web Appendix

Saving and Investment in Large Open Economies
Chapter 5
Money and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
What Is Money? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Meaning of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Functions of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
Unusual Forms of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
The Federal Reserve System and the Control
of the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Federal Reserve Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
Board of Governors of the Federal Reserve System . . . . . . . . . . . . . . . 105
Federal Open Market Committee (FOMC) . . . . . . . . . . . . . . . . . . . . . . 105
The European Central Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
Control of the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
Measuring Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
The Federal Reserve’s Monetary Aggregates . . . . . . . . . . . . . . . . . . . . 106
Where Is All the U.S. Currency? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
The Fed’s Use of M1 Versus M2 in Practice . . . . . . . . . . . . . . . . . . . . 107
Macroeconomics in the News: The Monetary
Aggregates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
Quantity Theory of Money . . . . . . . . . . . . . . . . . . . . . . . . 109
Velocity of Money and the Equation of Exchange . . . . . . . . . . . . . . . . . 109
From the Equation of Exchange to the Quantity Theory
of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
The Classical Dichotomy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
Quantity Theory and the Price Level . . . . . . . . . . . . . . . . . . . . . . . . . 111
Quantity Theory and Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
Application: Testing the Quantity Theory of Money . . . . . . . . . . . . . 112
Hyperinflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
POLICY AND PRACTICE: The Zimbabwean
Hyperinflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
Inflation and Interest Rates . . . . . . . . . . . . . . . . . . . . . . 116
Application: Testing the Fisher Effect . . . . . . . . . . . . . . . . . . . . . . 116
The Cost of Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
Costs of Anticipated Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
Costs of Unanticipated Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
Review Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
Contents xiii
Chapter 5 Appendix
The Money Supply Process . . . . . . . . . . . . . . . . . . . . . . . . 125
The Fed’s Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . 125
Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
Control of the Monetary Base . . . . . . . . . . . . . . . . . . . . . 126
Federal Reserve Open Market Operations . . . . . . . . . . . . . . . . . . . . . . 127
Shifts from Deposits into Currency . . . . . . . . . . . . . . . . . . . . . . . . . . 127
Discount Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
Overview of the Fed’s Ability to Control the
Monetary Base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
Multiple Deposit Creation: A Simple Model . . . . . . . . . . 129
Deposit Creation: The Single Bank . . . . . . . . . . . . . . . . . . . . . . . . . . 129
Deposit Creation: The Banking System . . . . . . . . . . . . . . . . . . . . . . . . 130
Critique of the Simple Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
Factors that Determine the Money Supply . . . . . . . . . . . 133
Changes in the Nonborrowed Monetary Base . . . . . . . . . . . . . . . . . . . . 133
Changes in Borrowed Reserves from the Fed . . . . . . . . . . . . . . . . . . . . 133
Changes in the Required Reserve Ratio . . . . . . . . . . . . . . . . . . . . . . . 133
Changes in Currency Holdings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
Changes in Excess Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
Overview of the Money Supply Process . . . . . . . . . . . . . . . . . . . . . . . . 134
The Money Multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
Deriving the Money Multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
Intuition Behind the Money Multiplier . . . . . . . . . . . . . . . . . . . . . . . . 137
Money Supply Response to Changes in the Factors . . . . . . . . . . . . . . . 138
Application: Quantitative Easing and
the Money Supply, 2007–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
Review Questions and Problems . . . . . . . . . . . . . . . . . . . 142

Application: The Great Depression Bank Panics and
the Money Supply, 1930–1933
PART 3 Long-Run Economic Growth . . . . . . . . . . . . 144

Chapter 6
The Sources of Growth and the Solow Model . . . . . . . . 146
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
Economic Growth Around the World . . . . . . . . . . . . . . . 147
The Solow Growth Model . . . . . . . . . . . . . . . . . . . . . . . . . 148
Building Blocks of the Solow Growth Model . . . . . . . . . . . . . . . . . . . . 148
Time Subscripts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
Dynamics of the Solow Growth Model . . . . . . . . . . . . . . . . . . . . . . . . 152
Convergence in the Solow Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
The “Bathtub Model” of the Steady State . . . . . . . . . . . . . . . . . . . . . . 153
xiv Contents
Application: Evidence on Convergence, 1960–2012 . . . . . . . . . . . . 154

War, Destruction, and Growth Miracles . . . . . . . . . . . . . . . . . . . . . . . . 156
Saving Rate Changes in the Solow Model . . . . . . . . . . . . 156
Population Growth in the Solow Model . . . . . . . . . . . . . 159
Population Growth and the Steady State . . . . . . . . . . . . . . . . . . . . . . 159
Changes in Population Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161
Population Growth and Real GDP Per Capita . . . . . . . . . . . . . . . . . . . 161
POLICY AND PRACTICE: China’s One-Child Policy and Other
Policies to Limit Population Growth . . . . . . . . . . . . . . . . . . . . . . . . . . 163
Productivity Growth in the Solow Model . . . . . . . . . . . 164
Technology Growth and the Steady State . . . . . . . . . . . . . . . . . . . . . . 164
Summing Up the Solow Model . . . . . . . . . . . . . . . . . . . . . 164
Solow Model: The Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164
Solow Model: Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
Sources of Economic Growth: Growth Accounting . . . 166
Growth Accounting Equation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
Growth Accounting in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
Application: U.S. Growth Rates in the
Postwar Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
Cross-Country Differences in Growth
Accounting Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172
Chapter 6 Appendix
The Algebra of the Solow Growth Model . . . . . . . . . . . . 176
Solving for the Steady State . . . . . . . . . . . . . . . . . . . . . . 176
Summary and Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177

The Golden Rule Level of the Capital-Labor Ratio
Chapter 7
Drivers of Growth: Technology, Policy,
and Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178
Technology as a Production Input . . . . . . . . . . . . . . . . . 178
Technology Versus Conventional Production Inputs . . . . . . . . . . . . . . . 179
Technology and Excludability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179
Policies to Promote Productivity . . . . . . . . . . . . . . . . . . 179
Building Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179
Increasing Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Contents xv
POLICY AND PRACTICE: Government Measures to

Increase Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180
Encouraging Research and Development . . . . . . . . . . . . . . . . . . . . . . 181
Institutions and Property Rights . . . . . . . . . . . . . . . . . . 183
The Legal System and Property Rights . . . . . . . . . . . . . . . . . . . . . . . . 183
Geography, the Legal System, and Economic Growth . . . . . . . . . . . . . . 185
Obstacles to Effective Property Rights . . . . . . . . . . . . . . . . . . . . . . . . 185
POLICY AND PRACTICE: The World Bank’s Doing Business . . . . . . . . . 186
POLICY AND PRACTICE: Does Foreign Aid Work? . . . . . . . . . . . . . . . . 188
Endogenous Growth Theory . . . . . . . . . . . . . . . . . . . . . . . 189
Allocation of Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
Production Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190
Production of Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190
Sustained Growth in the Romer Model . . . . . . . . . . . . . . . . . . . . . . . . 191
Factors That Affect Endogenous Growth . . . . . . . . . . . 192
Effects of an Increase in the Fraction of the Population
Engaged in R&D, α . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
Effect of Changes in the Productiveness of R&D, χ . . . . . . . . . . . . . . . 194
Response to an Increase in the Total Population, N . . . . . . . . . . . . . . . 195
APPLICATION: Does Population Growth Improve Living Standards? . . . . 196
The Romer Model and Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200
PART 4 Business Cycles: The Short Run . . . . . . . . . . 204

Chapter 8
Business Cycles: An Introduction . . . . . . . . . . . . . . . . . . 207
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
Business Cycle Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
Business Cycle Illustration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208
An Alternative View of the Business Cycle . . . . . . . . . . . . . . . . . . . . . 208
Co-Movement and Timing of Economic Variables . . . . . . . . . . . . . . . . . 209
Dating Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
Macroeconomic Variables and the Business Cycle . . . . 211
Real GDP and Its Components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211
Macroeconomics in the News: Leading Economic
Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211
Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212
Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212
Financial Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215
International Business Cycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216
A Brief History of U.S. Business Cycles . . . . . . . . . . . . . 217
Pre–World War I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
The Interwar Period and the Great Depression . . . . . . . . . . . . . . . . . . 220
Post–World War II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
The “Great Moderation” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
The Great Recession of 2007–2009 . . . . . . . . . . . . . . . . . . . . . . . . . 221
xvi Contents
Time Horizons in Macroeconomics . . . . . . . . . . . . . . . . . 221

Keynesian and Classical Views on Economic
Fluctuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221
The Short Run Versus the Long Run . . . . . . . . . . . . . . . . . . . . . . . . . 222
Price Stickiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
Perfect Competition Versus Monopolistic Competition . . . . . . . . . . . . . 223
Sources of Price Stickiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
Empirical Evidence for Price Stickiness . . . . . . . . . . . . . . . . . . . . . . . 224
Road Map for Our Study of Business Cycles . . . . . . . . . 225
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
Chapter 9
The IS Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231
Planned Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231
The Components of Expenditure . . . . . . . . . . . . . . . . . . . 232
Consumption Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
Planned Investment Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233
Net Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235
Government Purchases and Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 236
Goods Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . 237
Solving for Goods Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . 237
Deriving the IS Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238
Understanding the IS Curve . . . . . . . . . . . . . . . . . . . . . . . 238
What the IS Curve Tells Us: Intuition . . . . . . . . . . . . . . . . . . . . . . . . . 238
What the IS Curve Tells Us: Numerical Example . . . . . . . . . . . . . . . . . 239
Why the Economy Heads Toward Equilibrium . . . . . . . . . . . . . . . . . . . 239
Why the IS Curve Has Its Name and Its Relationship with
the Saving-Investment Diagram . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240
Factors That Shift the IS Curve . . . . . . . . . . . . . . . . . . . . 241
Changes in Government Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . 242
APPLICATION: The Vietnam War Buildup,
1964–1969 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243
Changes in Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244
Changes in Autonomous Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
POLICY AND PRACTICE: The Fiscal Stimulus
Package of 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
Changes in Financial Frictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246
Summary of Factors That Shift the IS Curve . . . . . . . . . . . . . . . . . . . . 246
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248
Contents xvii
Chapter 10
Monetary Policy and Aggregate Demand . . . . . . . . . . . . 251
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251
The Federal Reserve and Monetary Policy . . . . . . . . . . . 251
The Monetary Policy Curve . . . . . . . . . . . . . . . . . . . . . . . . 252
The Taylor Principle: Why the Monetary Policy Curve
Has an Upward Slope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253
Shifts in the MP Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254
Movements Along the MP Curve Versus Shifts in the Curve . . . . . . . . . . 254
POLICY AND PRACTICE: Movements Along the MP Curve:
The Rise in the Federal Funds Rate Target, 2004–2006 . . . . . . . . . . . 255
POLICY AND PRACTICE: Shifts in the MP Curve:
Autonomous Monetary Easing at the Onset of the
2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256
The Aggregate Demand Curve . . . . . . . . . . . . . . . . . . . . . . 257
Deriving the Aggregate Demand Curve Graphically . . . . . . . . . . . . . . . . 257
Factors That Shift the Aggregate Demand Curve . . . . . . . . . . . . . . . . . 257
Deriving the Aggregate Demand Curve Algebraically . . . . . . . . . . . . . . 259
The Money Market and Interest Rates . . . . . . . . . . . . . . 263
Liquidity Preference and the Demand for Money . . . . . . . . . . . . . . . . . 263
Demand Curve for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264
Supply Curve for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265
Equilibrium in the Money Market . . . . . . . . . . . . . . . . . . . . . . . . . . . 265
Changes in the Equilibrium Interest Rate . . . . . . . . . . . . . . . . . . . . . . 266
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270
Chapter 10 Appendix
The Demand for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . 273
Keynesian Theories of Money Demand . . . . . . . . . . . . . . 273
Transactions Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273
Precautionary Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273
Speculative Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274
Putting the Three Motives Together . . . . . . . . . . . . . . . . . . . . . . . . . . 274
Portfolio Theories of Money Demand . . . . . . . . . . . . . . . 275
Portfolio Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275
Portfolio Theory and Keynesian Liquidity Preference . . . . . . . . . . . . . . 275
Other Factors That Affect the Demand for Money . . . . . . . . . . . . . . . . 276
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276
Empirical Evidence on the Demand
for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276
Interest Rates and Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . 277
Stability of Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
xviii Contents
Chapter 11
Aggregate Supply and the Phillips Curve . . . . . . . . . . . 281
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281
The Phillips Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281
Phillips Curve Analysis in the 1960s . . . . . . . . . . . . . . . . . . . . . . . . . 282
POLICY AND PRACTICE: The Phillips Curve Tradeoff and
Macroeconomic Policy in the 1960s . . . . . . . . . . . . . . . . . . . . . . . . . 283
The Friedman-Phelps Phillips Curve Analysis . . . . . . . . . . . . . . . . . . . 283
The Phillips Curve After the 1960s . . . . . . . . . . . . . . . . . . . . . . . . . . 285
The Modern Phillips Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285
The Modern Phillips Curve with Adaptive (Backward-Looking)
Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286
The Aggregate Supply Curve . . . . . . . . . . . . . . . . . . . . . . . 287
Long-Run Aggregate Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
Short-Run Aggregate Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . 288
The Relationship of the Phillips Curve and the Short-Run
Aggregate Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291
Shifts in Aggregate Supply Curves . . . . . . . . . . . . . . . . . 291
Shifts in the Long-Run Aggregate Supply Curve . . . . . . . . . . . . . . . . . 291
Shifts in the Short-Run Aggregate Supply Curve . . . . . . . . . . . . . . . . . 292
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296
Chapter 12
The Aggregate Demand and Supply Model . . . . . . . . . . . 299
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
Recap of the Aggregate Demand
and Supply Curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
The Aggregate Demand Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299
Factors That Shift the Aggregate Demand Curve . . . . . . . . . . . . . . . . . 300
What Does Autonomous Mean? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301
Short- and Long-Run Aggregate Supply Curves . . . . . . . . . . . . . . . . . . 302
Factors that Shift the Long-Run Aggregate Supply Curve . . . . . . . . . . . 302
Factors that Shift the Short-Run Aggregate Supply Curve . . . . . . . . . . . 302
Equilibrium in Aggregate Demand and
Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303
Short-Run Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303
Algebraic Determination of the Equilibrium
Output and Inflation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304
Long-Run Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305
Short-Run Equilibrium over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305
Self-Correcting Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 307
Changes in Equilibrium: Aggregate Demand Shocks . . . 307
Algebraic Determination of the Response to a Rightward
Shift of the Aggregate Demand Curve . . . . . . . . . . . . . . . . . . . . . . . . 308
APPLICATION: The Volcker Disinflation, 1980–1986 . . . . . . . . . . . . . 309
APPLICATION: Negative Demand Shocks, 2001–2004 . . . . . . . . . . . . 310
Contents xix
Changes in Equilibrium: Aggregate Supply

(Price) Shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
Temporary Supply Shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311
APPLICATION: Negative Supply Shocks, 1973–1975
and 1978–1980 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313
Permanent Supply Shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314
APPLICATION: Positive Supply Shocks, 1995–1999 . . . . . . . . . . . . . . 316
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316
APPLICATION: Negative Supply and Demand Shocks
and the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . 318
AD/AS Analysis of Foreign Business Cycle Episodes . . . 319
APPLICATION: The United Kingdom and the 2007–2009
Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319
APPLICATION: China and the 2007–2009 Financial Crisis . . . . . . . . . 320
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324
Chapter 12 Web Appendix A

The Taylor Principle and Inflation Stability
Chapter 12 Web Appendix B

The Effects of Macroeconomic Shocks on Asset Prices
GO TO THE COMPANION WEBSITE, www.pearsonhighered.com/mishkin
Chapter 12 Web Appendix C

The Algebra of the Aggregate Demand and Supply Model
Chapter 13
Macroeconomic Policy and Aggregate
Demand and Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . 327
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327
The Objectives of Macroeconomic Policy . . . . . . . . . . . . 327
Stabilizing Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328
Stabilizing Inflation: Price Stability . . . . . . . . . . . . . . . . . . . . . . . . . . 329
Establishing Hierarchical Versus Dual Mandates . . . . . . . . . . . . . . . . . 329
The Relationship Between Stabilizing
Inflation and Stabilizing Economic Activity . . . . . . . . . 330
Monetary Policy and the Equilibrium Real Interest Rate . . . . . . . . . . . . 330
POLICY AND PRACTICE: The Federal Reserve’s Use of the
Equilibrium Real Interest Rate, r* . . . . . . . . . . . . . . . . . . . . . . . . . . . 332
Response to an Aggregate Demand Shock . . . . . . . . . . . . . . . . . . . . . 332
Response to a Permanent Supply Shock . . . . . . . . . . . . . . . . . . . . . . . 336
Response to a Temporary Supply Shock . . . . . . . . . . . . . . . . . . . . . . . 337
xx Contents
The Bottom Line: The Relationship Between Stabilizing

Inflation and Stabilizing Economic Activity . . . . . . . . . . . . . . . . . . . . . 341
How Actively Should Policy Makers Try to
Stabilize Economic Activity? . . . . . . . . . . . . . . . . . . . . . . . 343
Lags and Policy Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343
POLICY AND PRACTICE: The Activist/Nonactivist Debate
Over the Obama Fiscal Stimulus Package . . . . . . . . . . . . . . . . . . . . . . 344
The Taylor Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345
The Taylor Rule Equation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345
The Difference Between the Taylor Rule and the Taylor Principle . . . . . 346
The Taylor Rule Versus the Monetary Policy Curve . . . . . . . . . . . . . . . . 346
The Taylor Rule in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347
POLICY AND PRACTICE: The Fed’s Use of the Taylor Rule . . . . . . . . . . 347
Inflation: Always and Everywhere
a Monetary Phenomenon . . . . . . . . . . . . . . . . . . . . . . . . . . 348
Causes of Inflationary Monetary Policy . . . . . . . . . . . . 350
High Employment Targets and Inflation . . . . . . . . . . . . . . . . . . . . . . . 350
Application: The Great Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . 354
Monetary Policy at the Zero Lower Bound . . . . . . . . . . . 355
Deriving the Aggregate Demand Curve with the Zero
Lower Bound . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355
The Disappearance of the Self-Correcting
Mechanism at the Zero Lower Bound . . . . . . . . . . . . . . . . . . . . . . . . . 357
Application: Nonconventional Monetary
Policy and Quantitative Easing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 358
Liquidity Provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359
Asset Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359
Quantitative Easing Versus Credit Easing . . . . . . . . . . . . . . . . . . . . . . 360
Management of Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 361
POLICY AND PRACTICE: Abenomics and the Shift in
Japanese Monetary Policy in 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . 362
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 366
PART 5 Finance and the Macroeconomy . . . . . . . . . 370

Chapter 14
The Financial System and Economic Growth . . . . . . . . . 372
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372
The Role of the Financial System . . . . . . . . . . . . . . . . . . 372
Direct Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373
Indirect Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374
Information Challenges and the Financial System . . . 374
Asymmetric Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374
Financial Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375
Free-Rider Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376
Financial Intermediaries Address Asymmetric Information Problems . . . 377
Collateral and Asymmetric Information Problems . . . . . . . . . . . . . . . . 380
Contents xxi
APPLICATION: The Tyranny of Collateral . . . . . . . . . . . . . . . . . . . . . . 380

Government Regulation and Supervision
of the Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . 381
Government Regulation to Promote Transparency . . . . . . . . . . . . . . . . 381
Government-Directed Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382
Government Safety Net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 382
The Enron Implosion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383
Role of Prudential Regulation and Supervision . . . . . . . . . . . . . . . . . . 384
Financial Development and Economic
Growth: The Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384
Application: Is China a Counter-Example to the Importance
of Financial Development to Economic Growth? . . . . . . . . . . . . . . . . . 386
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388

Free Trade, Financial Globalization,
and Growth
Chapter 15
Financial Crises and the Economy . . . . . . . . . . . . . . . . . . 391
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391
Asymmetric Information and Financial
Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 392
Asymmetric Information Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . 392
What Is a Financial Crisis? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 392
Dynamics of Financial Crises . . . . . . . . . . . . . . . . . . . . . . 392
Stage One: Initiation of Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . 393
Stage Two: Banking Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396
Stage Three: Debt Deflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397
Application: The Mother of All Financial Crises:
The Great Depression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397
Stock Market Crash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398
Bank Panics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398
Adverse Selection and Moral Hazard Worsen . . . . . . . . . . . . . . . . . . . . 398
Debt Deflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 399
Recovery Begins . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400
International Dimensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400
APPLICATION: The Global Financial Crisis of
2007–2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400
Causes of the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . . . 400
Collateralized Debt Obligations (CDOs) . . . . . . . . . . . . . . . . . . . . . . . 401
Effects of the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . . . 402
Residential Housing Prices: Boom and Bust . . . . . . . . . . . . . . . . . . . . 402
POLICY AND PRACTICE: Was the Fed to Blame for the
Housing Price Bubble? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
xxii Contents
Ireland and the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . 406

Height of the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . . . 407
Why the 2007–2009 Financial Crisis Did Not Lead
to a Depression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 408
Aggressive Federal Reserve Actions . . . . . . . . . . . . . . . . . . . . . . . . . . 408
POLICY AND PRACTICE: The Federal Reserve’s Nonconventional
Monetary Policies and Quantitative Easing During the
Global Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409
Liquidity Provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409
Asset Purchases (Quantitative Easing) . . . . . . . . . . . . . . . . . . . . . . . . 410
Management of Expectations: Commitment to Future Policy Actions . . . 411
Worldwide Government Intervention Through Bailouts . . . . . . . . . . . . . 413
Aggressive Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413
POLICY AND PRACTICE: Japan’s Lost Decade, 1992–2002 . . . . . . . . . 414
Policy Response to Asset-Price Bubbles . . . . . . . . . . . . 415
Types of Asset-Price Bubbles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415
POLICY AND PRACTICE: Debate Over
Central Bank Response to Bubbles . . . . . . . . . . . . . . . . . . . . . . . . . . 416
Regulatory Policy Responses to Asset Bubbles . . . . . . . . . . . . . . . . . . 418
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 419
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 419
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 420
PART 6 Macroeconomic Policy . . . . . . . . . . . . . . . . 425

Chapter 16
Fiscal Policy and the Government Budget . . . . . . . . . . . 427
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427
The Government Budget . . . . . . . . . . . . . . . . . . . . . . . . . . 427
Government Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 430
Budget Deficits and Surpluses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 430
Government Budget Constraint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431
Size of the Government Debt . . . . . . . . . . . . . . . . . . . . . . 431
Growth of U.S. Government Debt over Time . . . . . . . . . . . . . . . . . . . . 431
POLICY AND PRACTICE: The Entitlements Debate: Social
Security and Medicare/Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . 433
International Comparison: The Size of Government Debt . . . . . . . . . . . 435
Sovereign Debt Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435
POLICY AND PRACTICE: The European Sovereign Debt Crisis . . . . . . . 436
Fiscal Policy and the Economy in the Long Run . . . . . . 437
Why High Government Debt Is Not a Burden . . . . . . . . . . . . . . . . . . . 437
Why High Government Debt Is a Burden . . . . . . . . . . . . . . . . . . . . . . 437
POLICY AND PRACTICE: Tax Smoothing . . . . . . . . . . . . . . . . . . . . . . 439
Fiscal Policy and the Economy in the Short Run . . . . . 440
Aggregate Demand and Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . 440
Expenditure and Tax Multipliers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440
POLICY AND PRACTICE: The 2009 Debate Over
Tax-Based Versus Spending-Based Fiscal Stimulus . . . . . . . . . . . . . . . 442
Contents xxiii
Fiscal Multipliers at the Zero Lower Bound . . . . . . . . . . . . . . . . . . . . . 443

Aggregate Supply and Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . 444
Supply-Side Economics and Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . 445
Balancing the Budget: Expansionary or Contractionary? . . . . . . . . . . . . 446
POLICY AND PRACTICE: Two Expansionary Fiscal
Contractions: Denmark and Ireland . . . . . . . . . . . . . . . . . . . . . . . . . . 447
POLICY AND PRACTICE: The Debate Over Fiscal
Austerity in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 448
Budget Deficits and Inflation . . . . . . . . . . . . . . . . . . . . . 449
Government-Issued Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449
Revenue from Seignorage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450
Budget Deficits and Ricardian Equivalence . . . . . . . . . . 450
Implications of Ricardian Equivalence . . . . . . . . . . . . . . . . . . . . . . . . 451
Objections to Ricardian Equivalence . . . . . . . . . . . . . . . . . . . . . . . . . 452
Bottom Line on Ricardian Equivalence . . . . . . . . . . . . . . . . . . . . . . . . 452
POLICY AND PRACTICE: The Bush Tax Cuts and
Ricardian Equivalence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456

Other Measures of the Government Budget Deficit
Chapter 17
Exchange Rates and International
Economic Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459
Foreign Exchange Market and Exchange Rates . . . . . . . 459
Foreign Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459
The Distinction Between Real and Nominal Exchange Rates . . . . . . . . . 460
MACROECONOMICS IN THE NEWS: Foreign
Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461
The Importance of Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . 461
Foreign Exchange Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463
Exchange Rates in the Long Run . . . . . . . . . . . . . . . . . . . 463
Law of One Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463
Theory of Purchasing Power Parity . . . . . . . . . . . . . . . . . . . . . . . . . . . 464
Big Macs and PPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464
Exchange Rates in the Short Run . . . . . . . . . . . . . . . . . . 466
Supply Curve for Domestic Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 466
Demand Curve for Domestic Assets . . . . . . . . . . . . . . . . . . . . . . . . . . 466
Equilibrium in the Foreign Exchange Market . . . . . . . . . . . . . . . . . . . . 467
Analysis of Changes in Exchange Rates . . . . . . . . . . . . . 468
Changes in the Demand for Domestic Assets . . . . . . . . . . . . . . . . . . . 468
APPLICATION: The Global Financial Crisis and the Dollar . . . . . . . . . . 471
xxiv Contents
APPLICATION: Why Are Exchange Rates So Volatile? . . . . . . . . . . . . . 473

Exchange Rates and Aggregate Demand
and Supply Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 473
Intervention in the Foreign Exchange Market . . . . . . . 475
Foreign Exchange Intervention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475
Intervention and the Exchange Rate . . . . . . . . . . . . . . . . . . . . . . . . . 476
Fixed Exchange Rate Regimes . . . . . . . . . . . . . . . . . . . . . . 477
Fixed Exchange Rate Regime Dynamics . . . . . . . . . . . . . . . . . . . . . . . 477
The Policy Trilemma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 479
Monetary Unions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480
Application: How Did China Accumulate Over $3 Trillion of
International Reserves? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481
POLICY AND PRACTICE: Will the Euro Survive? . . . . . . . . . . . . . . . . . 482
To Peg or Not to Peg . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482
Advantages of Exchange-Rate Pegging . . . . . . . . . . . . . . . . . . . . . . . . 482
Disadvantages of Exchange-Rate Pegging . . . . . . . . . . . . . . . . . . . . . . 483
POLICY AND PRACTICE: The Collapse of the Argentine
Currency Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 488
Chapter 17 Web Appendix A

The Interest Parity Condition
Chapter 17 Web Appendix B

Speculative Attacks and Foreign Exchange Crises
PART 7 Microeconomic Foundations of

Macroeconomics . . . . . . . . . . . . . . . . . . . . 492
Chapter 18
Consumption and Saving . . . . . . . . . . . . . . . . . . . . . . . . . . 494
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 494
The Relationship Between Consumption and Saving . . . 494
Intertemporal Choice and Consumption . . . . . . . . . . . . 495
The Intertemporal Budget Constraint . . . . . . . . . . . . . . . . . . . . . . . . . 495
The Intertemporal Budget Constraint in Terms of
Present Discounted Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497
Preferences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498
Optimization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499
The Intertemporal Choice Model in Practice:
Income and Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500
Response of Consumption to Income . . . . . . . . . . . . . . . . . . . . . . . . . 501
Response of Consumption to Wealth . . . . . . . . . . . . . . . . . . . . . . . . . 502
Consumption Smoothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502
Contents xxv
The Intertemporal Choice Model in Practice:

Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502
Interest Rates and the Intertemporal Budget Line . . . . . . . . . . . . . . . . 502
The Optimal Level of Consumption and the Intertemporal
Budget Line . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502
Borrowing Constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 504
The Keynesian Theory of Consumption . . . . . . . . . . . . . . 506
The Keynesian Consumption Function:
Building Blocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 506
Keynesian Consumption Function . . . . . . . . . . . . . . . . . . . . . . . . . . . 507
The Relationship of the Keynesian Consumption
Function to Intertemporal Choice . . . . . . . . . . . . . . . . . . . . . . . . . . . 507
The Permanent Income Hypothesis . . . . . . . . . . . . . . . . . 508
The Permanent Income Consumption Function . . . . . . . . . . . . . . . . . . 508
APPLICATION: Consumer Confidence and the Business Cycle . . . . . . . . 509
Relationship of the Permanent Income Hypothesis and
Intertemporal Choice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509
MACROECONOMICS IN THE NEWS: The Consumer Confidence and
Consumer Sentiment Indices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510
POLICY AND PRACTICE: The 2008 Tax Rebate . . . . . . . . . . . . . . . . . 510
The Life-Cycle Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . 511
Life-Cycle Consumption Function . . . . . . . . . . . . . . . . . . . . . . . . . . . 511
Saving and Wealth Over the Life Cycle . . . . . . . . . . . . . . . . . . . . . . . . 513
APPLICATION: Housing, the Stock Market, and the
Collapse of Consumption in 2008 and 2009 . . . . . . . . . . . . . . . . . . . 515
Two Modifications of the Theory: The Random
Walk Hypothesis and Behavioral Economics . . . . . . . . . 515
The Random Walk Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515
Behavioral Economics and Consumption . . . . . . . . . . . . . . . . . . . . . . 516
POLICY AND PRACTICE: Behavioral Policies to
Increase Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 517
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 518
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520

Income and Substitution Effects: A Graphical Analysis
Chapter 19
Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523
Data on Investment Spending . . . . . . . . . . . . . . . . . . . . . . 523
The Neoclassical Theory of Investment . . . . . . . . . . . . . 524
Determining the Level of Capital Stock . . . . . . . . . . . . . . . . . . . . . . . 524
User Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525
Determining the Desired Level of Capital . . . . . . . . . . . . . . . . . . . . . . 526
From the Desired Level of Capital to Investment . . . . . . . . . . . . . . . . . 527
xxvi Contents
Changes in the Desired Level of the Capital Stock . . . . . . . . . . . . . . . . 529

Summary: Neoclassical Theory of Investment . . . . . . . . . . . . . . . . . . . 532
Inventory Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534
Motivation for Holding Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . 534
The Theory of Inventory Investment . . . . . . . . . . . . . . . . . . . . . . . . . . 535
Tobin’s q and Investment . . . . . . . . . . . . . . . . . . . . . . . . . 536
Tobin’s q Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 536
Tobin’s q Versus Neoclassical Theory . . . . . . . . . . . . . . . . . . . . . . . . . 536
APPLICATION: Stock Market Crashes and Recessions . . . . . . . . . . . . . 537
Residential Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . 537
POLICY AND PRACTICE: U.S. Government Policies and the
Housing Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 538
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 541

A Model of Housing Prices and Residential Investment
Chapter 20
The Labor Market, Employment, and
Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544
Developments in the U.S. Labor Market . . . . . . . . . . . . . 544
Employment Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544
Unemployment Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546
Real Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546
Supply and Demand in the Labor Market . . . . . . . . . . . . 547
The Demand Curve for Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 548
The Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549
Equilibrium in the Labor Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549
Response of Employment and Wages to Changes
in Labor Demand and Labor Supply . . . . . . . . . . . . . . . . . 549
Changes in Labor Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549
Changes in Labor Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550
APPLICATION: Why Has Labor Force Participation of
Women Increased? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 551
APPLICATION: Why Are Income Inequality and Returns to
Education Increasing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 552
Dynamics of Unemployment . . . . . . . . . . . . . . . . . . . . . . . 554
Flows Into and Out of Employment Status . . . . . . . . . . . . . . . . . . . . . 555
Duration of Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556
Causes of Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . 556
Frictional Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556
POLICY AND PRACTICE: Unemployment
Insurance and Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557
Contents xxvii
Structural Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558

Wage Rigidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558
POLICY AND PRACTICE: Minimum Wage Laws . . . . . . . . . . . . . . . . . . 559
Efficiency Wages and Henry Ford . . . . . . . . . . . . . . . . . . . . . . . . . . . 561
Natural Rate of Unemployment . . . . . . . . . . . . . . . . . . . . 561
The Role of the Natural Rate of Unemployment in the AD/AS Model . . . 562
Sources of Changes in the Natural Rate of Unemployment . . . . . . . . . . 562
APPLICATION: Why Are European Unemployment Rates
Generally Much Higher Than U.S. Unemployment Rates? . . . . . . . . . . . 564
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 567
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 567
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568
PART 8 Modern Business Cycle Analysis and

Macroeconomic Policy . . . . . . . . . . . . . . . . 571
Chapter 21
The Role of Expectations in Macroeconomic Policy . . . 573
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573
Rational Expectations and Policy Making . . . . . . . . . . . . 573
Adaptive Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573
Rational Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574
Microeconomic Rationale Behind the Theory . . . . . . . . . . . . . . . . . . . 575
Rational Expectations Theory and Macroeconomic Analysis . . . . . . . . . 575
Rational Expectations Revolution . . . . . . . . . . . . . . . . . . . . . . . . . . . 576
Lucas Critique of Policy Evaluation . . . . . . . . . . . . . . . . 576
Econometric Policy Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 576
APPLICATION: The Consumption Function . . . . . . . . . . . . . . . . . . . . . 577
Policy Conduct: Rules or Discretion? . . . . . . . . . . . . . . . 577
Discretion and the Time-Inconsistency Problem . . . . . . . . . . . . . . . . . 577
Types of Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578
The Case for Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 579
POLICY AND PRACTICE: The Political Business Cycle and
Richard Nixon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 579
The Case for Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 580
POLICY AND PRACTICE: The Demise of Monetary
Targeting in Switzerland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 581
Constrained Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 581
The Role of Credibility and a Nominal Anchor . . . . . . . 582
Benefits of a Credible Nominal Anchor . . . . . . . . . . . . . . . . . . . . . . . . 582
Credibility and Aggregate Demand Shocks . . . . . . . . . . . . . . . . . . . . . 582
Credibility and Aggregate Supply Shocks . . . . . . . . . . . . . . . . . . . . . . 584
APPLICATION: A Tale of Three Oil Price Shocks . . . . . . . . . . . . . . . . . 585
Approaches to Establishing Central
Bank Credibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587
Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587
POLICY AND PRACTICE: Ben Bernanke and the Federal
Reserve Adoption of Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . 588
Nominal GDP Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589
xxviii Contents
Appoint “Conservative” Central Bankers . . . . . . . . . . . . . . . . . . . . . . . 589

POLICY AND PRACTICE: The Appointment of Paul Volcker,
Anti-Inflation Hawk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 590
Increase Central Bank Independence . . . . . . . . . . . . . . . . . . . . . . . . . 590
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594
Chapter 22
Modern Business Cycle Theory . . . . . . . . . . . . . . . . . . . . 597
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 597
Real Business Cycle Model . . . . . . . . . . . . . . . . . . . . . . . . 597
Productivity Shocks and Business Cycle Fluctuations . . . . . . . . . . . . . 598
Solow Residuals and Business Cycle Fluctuations . . . . . . . . . . . . . . . . 599
Employment and Unemployment in the Real Business Cycle Model . . . 599
Objections to the Real Business Cycle Model . . . . . . . . . . . . . . . . . . . 600
New Keynesian Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . 601
Building Blocks of the New Keynesian Model . . . . . . . . . . . . . . . . . . . 602
Business Cycle Fluctuations in the New Keynesian Model . . . . . . . . . . 605
Objections to the New Keynesian Model . . . . . . . . . . . . . . . . . . . . . . . 606
A Comparison of Business Cycle Models . . . . . . . . . . . . 607
How Do the Models Differ? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 607
Short-Run Output and Price Responses: Implications for
Stabilization Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 608
Anti-Inflation Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 612
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 616

The New Classical Model
Epilogue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619
Policy and Practice: Where Do Macroeconomists
Agree and Disagree? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619
Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 619
Where Macroeconomists Agree . . . . . . . . . . . . . . . . . . . . 619
Inflation Is Always and Everywhere a Monetary Phenomenon . . . . . . . . 620
The Benefits of Price Stability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 620
No Long-Run Trade-off Between Unemployment and Inflation . . . . . . . . 620
The Crucial Role of Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621
The Taylor Principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622
The Time-Inconsistency Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622
Central Bank Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623
Contents xxix
Commitment to a Nominal Anchor . . . . . . . . . . . . . . . . . . . . . . . . . . . 623

Credibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623
Institutions Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 624
Where Macroeconomists Disagree . . . . . . . . . . . . . . . . . 624
Flexibility of Wages and Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 624
How Much Time It Takes to Get to the Long Run . . . . . . . . . . . . . . . . . 624
Sources of Business Cycle Fluctuations . . . . . . . . . . . . . . . . . . . . . . . 625
Effectiveness of Stabilization Policy . . . . . . . . . . . . . . . . . . . . . . . . . 626
Cost of Reducing Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 626
The Dangers of Budget Deficits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 627
The Future of Business Cycle Theory . . . . . . . . . . . . . . . 628
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 629
Key Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 629
Web Chapter
Financial Crises in Emerging Market Economies
Preview
Dynamics of Financial Crises in Emerging
Market Economies
Stage One: Initiation of Financial Crisis
Stage Two: Currency Crisis
Stage Three: Full-Fledged Financial Crisis
APPLICATION: Crisis in South Korea, 1997–1998
Financial Liberalization/Globalization Mismanagement
Perversion of the Financial Liberalization/Globalization Process: Chaebols and the South Korean Crisis
Stock Market Decline and Failure of Firms Increase Uncertainty
Aggregate Selection and Moral Hazard Problems Worsen, and Aggregate Demand Falls
Currency Crisis Ensues
Final Stage: Currency Crisis Triggers Full-Fledged Financial Crisis
Recovery Commences
APPLICATION: The Argentine Financial Crisis, 2001–2002
Severe Fiscal Imbalances
Adverse Selection and Moral Hazard Problems Worsen
Bank Panic Begins
Currency Crisis Ensues
Currency Crisis Triggers Full-Fledged Financial Crisis
Recovery Begins
When an Advanced Economy Is Like an Emerging Market Economy:
The Icelandic Financial Crisis of 2008
POLICY AND PRACTICE: Preventing Emerging Market Financial Crises
Beef Up Prudential Regulation and Supervision of Banks
Encourage Disclosure and Market-Based Discipline
Limit Currency Mismatch
Sequence Financial Liberalization
Summary
Key Terms
Review Questions and Problems
Glossary G-1
Index I-1
Preface
There has never been a more exciting time to teach macroeconomics. The recent world-
wide financial crisis cast a spotlight on macroeconomics and prompted instructors
worldwide to rethink their teaching of the course. Students today enter the intermedi-
ate macroeconomics course knowing the relevance of the business cycle—it impacts
what is happening in their world right now, in the aftermath of the most severe reces-
sion since World War II. The silver lining of these trying economic times lies in our abil-
ity to draw on this familiarity and the rich tapestry of recent economic events to enliven
macroeconomic theory.
Macroeconomics: Policy and Practice, Second Edition, focuses on the policy issues
currently debated by the media and the public at large. Building on my expertise in
macroeconomic policy making at the Federal Reserve, I highlight the techniques used
by policy makers in practice. I ground this applied approach to intermediate macroeco-
nomics with a careful, step-by-step development of all models.
What’s New in the Second Edition

In addition to the expected updating of data through 2013 whenever possible, major
new material has been added in every part of the text.
Enhanced Pearson e-text with Mini-Lectures: A New Way of

Learning
The Enhanced Pearson e-text in MyEconLab for the second edition is available online
from MyEconLab textbook resources. Instructors and students can highlight the text,
bookmark, search the glossary, and take notes. More importantly, the e-text provides
a new way of learning that is particularly useful to today’s students. Not only are stu-
dents able to read the material in the textbook but, by a simple click on an icon, they are
able to watch over 100 mini-lectures presented by the author—one for every analytic
graph in the text. These mini-lectures build each graph step-by-step and explain the
intuition necessary to fully understand the theory behind the graph. The mini-lectures
are an invaluable study tool for students who typically learn better when they see and
hear economic analysis rather than read it.
Real-Time Data
A high percentage of the in-text data is labeled MyEconLab Real-Time Data. This label
indicates that students can view the latest data using the e-text to access the Federal
Reserve Bank of St. Louis’s FRED database. In addition, each chapter now has a
whole new class of problems that make use of real-time data analysis. These prob-
lems, marked with , ask students to download data from the Federal Reserve Bank
of St. Louis’s FRED website and then use that data to answer questions about current
issues in macroeconomics.
xxxi
xxxii preface
In MyEconLab, these easy-to-assign and automatically-graded Real-Time Data

Analysis exercises are linked directly to the FRED site, so that every time FRED posts
new data, students can see it. As a result, Real-Time Data Analysis exercises offer a
no-fuss solution for instructors who want to make the most recent data a central part
of their macroeconomics course. These exercises will help students understand mac-
roeconomics better and enable them to see the real-world relevance of their study of
macroeconomics.
Nonconventional Monetary Policy and the

Zero Lower Bound
In recent years, monetary policy makers have entered a brave new world in which they
have had to resort to nonconventional monetary policy because the policy interest rate,
the federal funds rate in the United States, has hit a floor of zero, the so-called “zero
lower bound.” The policy rate cannot be driven lower than this bound, making conven-
tional monetary policy infeasible. Nonconventional monetary policy at the zero lower
bound, such as quantitative easing, is very controversial and stimulates a lot of interest
among students. The second edition contains extensive discussion of this topic, with the
following new material:
• A new Application, “Quantitative Easing and the Money Supply, 2007–2013”
(Chapter 5)
• A new section on monetary policy at the zero lower bound, which uses the
dynamic aggregate demand and aggregate supply model to explain how the
zero lower bound affects the conduct of monetary policy (Chapter 13)
• A new Policy and Practice case, “Abenomics and the Shift in Japanese
Monetary Policy in 2013” (Chapter 13)
• A new Policy and Practice case, “Nonconventional Monetary Policy and
Quantitative Easing During the Global Financial Crisis” (Chapter 15)
• A new section on fiscal multipliers at the zero lower bound that explains why
fiscal multipliers are likely to be larger at the zero lower bound (Chapter 16)
• A new section on nominal GDP targeting (Chapter 21)
New Material on Business Cycle Analysis

This edition has substantial new material on business cycle analysis, to make it eas-
ier for students to understand the dynamic aggregate demand and aggregate supply
model. This new material includes:
• A new section on the alternative view of the business cycle, which distin-
guishes the long-run trend from deviations in this trend and introduces the
concept of the output gap (Chapter 8)
• New material that integrates the concept of financial frictions into the
dynamic aggregate demand and aggregate supply model at the outset, by
naming financial frictions as an additional factor that shifts the IS curve
(Chapter 10) and the AD curve (Chapter 12)
• A new section that clarifies the difference between movements along the
MP curve and shifts in the MP curve, with two new Policy and Practice
cases to illustrate the difference: “Movement Along the MP Curve: The Rise
in the Federal Funds Rate Target, 2004–2006” and “Shifts in the MP Curve:
preface xxxiii
Autonomous Monetary Easing at the Onset of the 2007–2009 Financial Crisis”

(Chapter 10)
• A new box, “What Does Autonomous Mean?” (Chapter 12)
• A new box, “The Relationship of the Phillips Curve and the Short-Run
Aggregate Supply Curve” (Chapter 11)
• A new box, “The Difference Between the Taylor Rule and the Taylor Principle”
(Chapter 13)
The Euro Crisis

The Euro crisis has been a continuing drama since 2010, and so this edition includes the
following new material.
• A new section on sovereign debt crises that explains the dynamics of these
crises (Chapter 16)
• A new Policy and Practice case, “The European Sovereign Debt Crisis”
(Chapter 16)
• A new Policy and Practice case, “The Debate Over Fiscal Austerity in Europe”
(Chapter 16)
• A new Policy and Practice case, “Will the Euro Survive?” (Chapter 17)
Economic Growth
To better motivate the discussion of the Solow model, Chapter 6 now begins with an
introductory section that examines economic growth around the world. Also, Chapter 6
has been reorganized so that growth accounting is discussed at the end of the chapter, in
order to better motivate Chapter 7 on the drivers of economic growth. New figures have
been added to Chapter 6 to show how output per worker changes over time when there
is a change in the saving rate, population growth, or technology.
Links Between the Microeconomic Foundations of

Macroeconomics and the Dynamic Aggregate
Demand/Aggregate Supply Model
To illustrate the links between the microeconomic material in Part 7 of the text and the
dynamic aggregate demand/aggregate supply model, I have added the following new
material:
• A new Application, “Consumer Confidence and the Business Cycle” (Chapter 18)
• A new Application, “Stock Market Crashes and Recessions” (Chapter 19)
• A new section on the role of the natural rate of unemployment in the AD/AS
model (Chapter 20)
Hallmarks
The five distinguishing characteristics of Macroeconomics: Policy and Practice, Second
Edition, are: (1) its emphasis on policy and practice, (2) its dynamic approach to macro-
economics, (3) its focus on the interaction between finance and macroeconomics, (4) its
focus on economic growth, and (5) its international perspective.
xxxiv preface
Policy And Practice

This book emphasizes policy and practice in macroeconomics by providing theoreti-
cal frameworks that are geared to discussing the most exciting, current, major policy
debates in the macroeconomics field. The best way to teach macroeconomics is by con-
tinually exposing the student to cases and applications so that he or she really under-
stands the underlying theory.
Over 30 in-chapter Applications show students how to apply economic theory to
real-world examples. These Applications include discussions of the Great Inflation
from 1965 to 1982, the 2007–2009 financial crisis, the impact of oil prices on real wages
and the stock market, why income inequality has been growing over time, and why
some countries are rich and others are poor. In addition, over 30 Policy and Practice
cases explore specific examples of actual policies and how they were executed. These
cases include such topics as how the Federal Reserve uses the Taylor rule, the use of
nonconventional monetary policy during the 2007–2009 financial crisis, the political
business cycle and Richard Nixon, the question of whether the Euro will survive, and
China’s one-child policy. These Applications and Policy and Practice cases provide criti-
cally important perspectives on current events, domestic and global issues, and histori-
cal episodes.
A Dynamic Approach To Macroeconomics

Analyzing today’s hot-button policy issues requires approaching macroeconomic the-
ory using the models that researchers and policy makers employ. The central modeling
element in Macroeconomics: Policy and Practice, Second Edition, is a powerful, dynamic
aggregate demand and supply (AD/AS) model that highlights the interaction of infla-
tion and economic activity. In this model, inflation (as opposed to the price level) is
plotted on the vertical axis.
Given the vital importance of this model, I build it step-by-step across Chapters 9–13:
• Chapter
9 develops the first building block of the aggregate demand and sup-
ply model, the IS curve.
• Chapter
10 describes how monetary policy makers set real interest rates with
the monetary policy (MP) curve, which describes the relationship between infla-
tion and real interest rates. The chapter then uses the MP curve and the IS
curve to derive the aggregate demand curve.
• Chapter 11 uses the Phillips curve to derive the aggregate supply curve.
• Chapter 12 assembles the building blocks from preceding chapters to develop
the aggregate demand and supply model, and then puts this model to imme-
diate use with Applications that analyze business cycle fluctuations in the
United States and abroad.
• Chapter 13 shifts perspective by showing how the aggregate demand and
supply model can help us understand the issues policy makers confront when
they attempt to stabilize inflation and output fluctuations.
The aggregate demand and supply model, with inflation on the vertical axis, there-
fore serves as the sole engine for the analysis of short-run fluctuations. Students benefit
from this exclusive focus and the careful development of a single model: Reliance on
the dynamic AD/AS model continually reinforces their understanding of the model and
provides a unified framework for all analysis.
preface xxxv
Why the Dynamic AD/AS Framework? The dynamic AD/AS model includes many
of the essential elements of the ISLM model. It develops the IS curve (Chapter 9) and
illustrates the determination of interest rates in the money market through the interac-
tion of money demand and supply (Chapter 10). However, the dynamic AD/AS model
has several very important advantages over ISLM and traditional aggregate demand/
aggregate supply frameworks:
• The dynamic AD/AS framework focuses on the interaction between inflation
and output, which is exactly what the media and policy makers focus on. In
contrast, traditional aggregate demand/aggregate supply analysis focuses on
the interaction between the price level and output.
• The dynamic AD/AS framework characterizes monetary policy easing or
tightening as a change in the interest rate, which is exactly the way central
banks conduct monetary policy. In contrast, the ISLM and traditional aggre-
gate demand/aggregate supply model frameworks characterize monetary
policy as a change in the money supply. No central bank in the world today
conducts monetary policy in this way.
• The dynamic AD/AS framework is consistent with modern macroeconomic
analysis as it is treated in the academic literature.
• The dynamic AD/AS framework allows for a simple analysis of current
monetary policy issues, such as nonconventional monetary policy and the
zero-lower-bound problem. In addition, it allows for a modern treatment
of such topical policy issues as the recent shift in monetary policy in Japan,
referred to as Abenomics, and why fiscal multipliers have become larger in
recent years.
• Finally, although the AD/AS framework is a change from the way macroeco-
nomics has been taught in the past, it actually makes it easier for students to
learn because they have to master only one model rather than three, as was
the case with more traditional approaches that include separate developments
of the ISLM model, traditional aggregate demand/aggregate supply, and the
Phillips curve.
The Interaction of Finance and Macroeconomics

The financial crisis that hit the world economy from 2007 to 2009 made abundantly
clear the interaction between finance and macroeconomics. Two full chapters on
finance and macroeconomics provide a coherent approach to key topics such as
financial system dynamics and asymmetric information, and demonstrate their rel-
evance in macroeconomic analysis. Chapter 14, “The Financial System and Economic
Growth,” shows how a well-functioning financial system promotes economic
growth. This chapter develops the tools that are then used in Chapter 15, “Financial
Crises and the Economy,” to examine how disruptions to the financial system affect
aggregate demand and the economy, with a particular emphasis on the root causes
of, effects of, and policy responses to the financial crisis of 2007–2009. An additional
Web chapter, “Financial Crises in Emerging Market Economies,” expands the analy-
sis of economic fluctuations to economies that have recently opened up their markets
to the outside world.
xxxvi preface
Focus On Economic Growth

The explosion of research on economic growth in recent years is an exciting development
in the macroeconomics field, with direct relevance to the question of why some countries
suffer slow economic growth and remain poor, while others enjoy rapid economic growth
and prosper. I discuss the Solow model in detail in Chapter 6, and present endogenous
growth theory and the importance of institutions to economic growth in Chapter 7. As
mentioned previously, Chapter 14 includes additional material on economic growth.
An International Perspective
Topical coverage and applications integrate an international dimension throughout
Macroeconomics: Policy and Practice, Second Edition. For example, Chapter 4’s analysis of
the interaction of saving and investment discusses open and closed economies together,
rather than in separate chapters. International trade and the impact of net exports on
aggregate demand are discussed immediately as part of the AD/AS model in Part 4,
as opposed to in a separate chapter, and the textbook applies the aggregate demand
and supply model to analyze the impact of the 2007–2009 financial crisis in the United
Kingdom, Ireland, and China. The Web chapter on emerging market economies pro-
vides further international perspective.
A Flexible Structure
Macroeconomics: Policy and Practice, Second Edition, offers a highly flexible structure
with many different paths that instructors can take to tailor the book to their course
needs. Most instructors will begin by assigning Chapters 1–4. For a long-run emphasis,
instructors can then assign Chapters 5–7. Instructors wishing to cover the short run first
can instead proceed directly to Part 4.
The core chapters that most instructors will teach in their courses, Chapters 1–13,
make up the first four parts of the book. Instructors can assign subsequent chapters
as they choose or skip them entirely, allowing them to focus on the particular areas of
macroeconomics that match their course goals. Suggested outlines for semester-long
courses with varying emphases follow. (Quarter-long courses would typically use three
or four fewer of the optional chapters.)
• Course Starting with Long-Run Analysis: Chapters 1–13, and up to six of the
remaining eleven chapters.
• Course Starting with Micro Foundations and Long-Run Analysis: Chapters 1–3,
18–20, 4–13, and up to three of the remaining eight chapters.
• Course Starting with Short-Run Analysis: Chapters 1–5, 8–13, 6–7, and up to six
of the remaining eleven chapters.
• Course Starting with Micro Foundations and Short-Run Analysis: Chapters 1–3,
18–20, 4–5, 8–13, 6–7, and up to three of the remaining eight chapters.
• Course Focusing on the Micro Foundations of Modern Business Cycle Analysis:
Chapters 1–3, 18–20, 4–5, 8–13, 21–22, and up to two of the remaining ten chapters.
• Course with International Focus: Chapters 1–13, 17, Web chapter on emerging
market economies, and up to four of the remaining nine chapters.
• Course with Finance Focus: Chapters 1–15, and up to four of the remaining
seven chapters.
preface xxxvii
Interest-Generating Features
Motivating the study of macroeconomics means bringing it to life through a wide vari-
ety of pedagogical features.
Previews at the beginning of each chapter tell students where the chapter is heading,
why specific topics are important, and how they relate to other topics in the book.
Applications apply the analysis in each chapter to explain important real-world situa-
tions.
Policy and Practice cases explore specific examples of actual policies and how they
were executed.
Macroeconomics in the News boxes introduce students to relevant news articles and
data that are reported daily in the press, and explain how to read them.
Boxes highlight interesting material, including historical episodes and recent events.
Summary tables are useful study aids that recap key points.
Key statements are important points set in boldface italic type so that the student can
easily find them for later reference.
Graphs with detailed captions demonstrate the interrelationship of the variables and
are central to the illustrations of policy analysis. Innovative color-blended arrows guide
students’ analysis of the meanings of shifting curves.
Mini-Lectures, presented by the author for all of the analytic graphs in the text, are
accessible through the e-text, which is available online from MyEconLab textbook
resources. The mini-lectures provide a step-by-step discussion of the analysis.
A Summary at the end of each chapter lists the main points covered.
Key terms, which are important words or phrases, are boldfaced when they are defined
for the first time and listed by page number at the end of each chapter.
End-of-chapter Review Questions, Problems, and Real-Time Data Analysis Problems
guide students’ mastery of the material, with a particular emphasis on real-world appli-
cations.
Supplemental Resources Simplify Teaching and Learning

A variety of comprehensive supplemental resources for professors and students accom-
pany this book.
MyEconLab is the premier online assessment and tutorial system, pairing rich online
content with innovative learning tools. The MyEconLab course for Macroeconomics:
Policy and Practice, Second Edition, includes all the review questions and problems from
the textbook. As a special feature, all Policy and Practice cases and Applications are also
offered in MyEconLab, along with three to four assessment questions to test students’
understanding of the key concepts. Look for these exercises within each chapter in a
separate section called “Applications."
Students and MyEconLab The MyEconLab online homework and tutorial system
puts students in control of their own learning through a suite of study and practice tools
correlated with the online, interactive version of the textbook and other media tools.
Within MyEconLab’s structured environment, students practice what they learn, test
their understanding, and then pursue a study plan that MyEconLab generates for them
based on their performance on practice tests.
xxxviii preface
Instructors and MyEconLab MyEconLab provides flexible tools that allow

instructors to easily and effectively customize online course materials to suit their needs.
Instructors can create and assign tests, quizzes, or homework assignments. MyEconLab
saves time by automatically grading questions and tracking results in an online grade
book. After registering for MyEconLab, instructors also have access to downloadable
supplements.
Additional MyEconLab Features

• Weekly News Updates. Each week, a relevant and current article from a
newspaper or journal is posted, along with discussion questions.
For more information and to register, please visit www.myeconlab.com.
Additional Instructor Resources The Instructor’s Manual, an online supple-

ment prepared by Martin Pereyra of the University of Missouri and the author, offers
chapter overviews, outlines and objectives, and answers to the end-of-chapter questions
and problems including solutions to the Data Analysis problems by Aaron Jackson of
Bentley University. Additionally, the Instructor’s Manual includes resources for each
chapter that tie into the Applications and Policy and Practice features of the chapter,
including discussion questions that professors can use in class with students, references
to interesting outside materials such as newspaper and journal articles and macroeco-
nomic data, and references to websites containing related real-world examples. The
Instructor’s Manual is available at www.pearsonhighered.com/irc in Microsoft Word
and PDF formats.
The PowerPoint Presentations, prepared by Jim Lee of Texas A&M University–
Corpus Christi, provide all figures and tables from the text, as well as brief lecture notes
that follow the structure and sequence of the text. They include coverage of the main
topics of the chapter, organized by A-head, the key terms and equations from the chap-
ter, and the Applications and Policy and Practice features in the chapter.
Animated PowerPoint Presentations, created by the author, are also available at
www.pearsonhighered.com/irc. These PowerPoint slides provide the analytical fig-
ures and are completely manipulable by the user. Instructors can custom design their
PowerPoint lectures with step-by-step animations of all key text figures.
The Test Item File, originally prepared by Paul Kubik of DePaul University, Victor
Valcarcel of Texas Tech University, and Brian Trinque of the University of Texas–Austin,
and updated for the second edition by Brian Trinque, provides 75 multiple-choice ques-
tions and 10 short-answer questions for each chapter. The questions provide a mix of
numerical, graphical, and conceptual approaches for all chapter topics. In addition, the
questions are MyEconLab-compatible and follow the Association to Advance Collegiate
Schools of Business (AACSB) tagging procedures. The Test Item File is available at
www.pearsonhighered.com/irc electronically in Microsoft Word format and as com-
puterized TestGen-format files that can be used with TestGen test-generating software.
This test-generating program permits instructors to edit, add, or delete questions from
the test bank; analyze test results; and organize a database of tests and student results,
allowing for flexibility and ease of use.
Additional Student Resources The Companion Website, located at www

.pearsonhighered.com/mishkin, features Web appendices on a wide variety of topics,
as well as a Web chapter, “Financial Crises in Emerging Market Economies.”
preface xxxix
Acknowledgments
There are many people to thank on this project. I have been blessed with three extraor-
dinary editors on this project: Noel Seibert, my original acquisitions editor; Adrienne
D’Ambrosio, my current acquisitions editor; and Rebecca Ferris-Caruso, my develop-
ment editor. Many thanks as well to members of the production, editorial, and market-
ing teams at Pearson: Kathryn Dinovo, Alison Eusden, Carolyn Philips, David Theisen,
Lori DeShazo, and Kathleen McLellan. I also want to thank Neil Mehrotra, Ozge Akinci,
and Jorge Mejia Licona for very helpful research assistance, and Daniel Sorid for giving
me the student’s perspective while providing me with invaluable editing. I have also
received insightful comments from my colleagues Marc Giannoni and Mark Gertler.
This book has been thoroughly accuracy checked through several rounds. I would
like to thank the accuracy reviewer, Jim Eaton, for his extraordinary efforts and atten-
tion to detail. In addition, I have received thoughtful comments from outside reviewers,
editorial board members, focus group participants, community call participants, and
class testers, who are listed below.
Reviewers:
Gilad Aharonovitz, Washington State Amitava Krishna Dutt, University of Notre
University Dame
S. Nuray Akin, University of Miami Jim Eaton, Bridgewater College
Lian An, University of North Florida Ryan Edwards, Queens College
S. Boragan Aruoba, University of Maryland Sharon Erenburg, Eastern Michigan
Elizabeth Asiedu, University of Kansas University
Nursel Aydiner-Avsar, University of Utah Alexander Field, Santa Clara University
Lance Bachmeier, Kansas State University Todd Fitch, University of California–Berkeley
Mina Baliamoune, University of North Hamilton Fout, Kansas State University
Florida Jean Gauger, The University of Tennessee
David Beckworth, Texas State University Ronald D. Gilbert, Texas Tech University
Cihan Bilginsoy, University of Utah George Heitmann, Muhlenberg College
Nicola Borri, Boston University Kolver Hernandez, University of Delaware
David Bunting, Eastern Washington Adam Honig, Amherst College
University Yu Hsing, Southeastern Louisiana University
Michael Carew, Baruch College of CUNY Ralph D. Husby, University of Illinois at
Joel D. Carton, Florida International Urbana–Champaign
University Kim Huynh, Indiana University–Bloomington
Marcelle Chauvet, University of California Murat Iyigun, University of Colorado–Boulder
Darian Chin, California State University–Los Aaron L. Jackson, Bentley University
Angeles Vivekanand Jayakumar, University of Tampa
Olivier Coibion, College of William Barry Jones, Binghamton University
and Mary Bryce Kanago, University of Northern Iowa
Firat Demir, University of Oklahoma Cem Karayalcin, Florida International
James Devine, Loyola Marymount University University–University Park
John Dogbey, Ohio University Arthur Kartman, San Diego State University
Fred Donatelli, Binghamton University John Keating, University of Kansas
Abdunasser Duella, California State Todd Keister, Rutgers University
University–Fullerton Elizabeth Sawyer Kelly, University of
Quentin Duroy, Denison University Wisconsin–Madison
xl preface
Jaebeom Kim, Oklahoma State University Nate Peach, George Fox University
Young Se Kim, University of North Texas Iordanis Petsas, University of Scranton
Gregory Krohn, Bucknell University David E. Rapach, Saint Louis University
Paul Kubik, DePaul University Dan Rickman, Oklahoma State University
Ken Kuttner, Williams College Joseph Santos, South Dakota State
Leonard Lardaro, University of Rhode Island University
Jim Lee, Texas A&M University–Corpus Andrei Shevchenko, Michigan State
Christi University
David I. Levine, University of California– Mark Siegler, California State University–
Berkeley Sacramento
Dennis Patrick Leyden, University of North Tara Sinclair, The George Washington
Carolina at Greensboro University
T. K. Lim, Carnegie Mellon University Svetlana Smirnov, University of
Bernard Malamud, University of Nevada–Las Massachusetts Lowell
Vegas Georg Strasser, Boston College
Kathryn G. Marshall, California Polytechnic Jack Strauss, St. Louis University
State University Aditi Thapar, New York University
John McArthur, Wofford College Rebecca Achee Thornton, University of
Steve McCafferty, Ohio State University Houston
Bruce McGough, Oregon State University Brian Trinque, University of Texas–Austin
W. Douglas McMillin, Louisiana State Kwok Pin Tsang, Virginia Polytechnic
University Institute and State University
Ellen E. Meade, American University Michelle Turnovsky, University of
Diego Mendez-Carbajo, Illinois Wesleyan Washington
University Geetha Vaidyanathan, University of North
Fabio Milani, University of California–Irvine Carolina–Chapel Hill
Olivier Morand, University of Connecticut Victor Valcarcel, Texas Tech University
Shahriar Mostashari, Campbell University Ann Villamil, University of Illinois
Jon Nadenichek, California State University– Charles S. Wassell, Central Washington
Northridge University
Kanda Naknoi, Purdue University Steven Wood, University of California–
John Neri, University of Maryland Berkeley
Farrokh Nourzad, Marquette University Bill Yang, Georgia Southern University
Phacharaphot Nuntramas, San Diego State Ben Young, University of Missouri
University Wei-Choun Yu, Winona State
Ron Olive, University of Massachusetts University
Lowell
Editorial Advisory Board:
Joel D. Carton, Florida International Mark Siegler, California State University–
University Sacramento
Jim Eaton, Bridgewater College Brian Trinque, University of Texas–Austin
Murat Iyigun, University of Colorado–Boulder Michelle Turnovsky, University of
Aaron L. Jackson, Bentley University Washington
Elizabeth Sawyer Kelly, University of Geetha Vaidyanathan, University of North
Wisconsin–Madison Carolina–Chapel Hill
Kathryn G. Marshall, California Polytechnic Victor Valcarcel, Texas Tech University
State University Bill Yang, Georgia Southern University
Olivier Morand, University of Connecticut
preface xli
Focus Group Participants:

Francis Ahking, University of Connecticut Louis Johnston, College of Saint Benedict
Serife Nuray Akin, University of Miami Saint John’s University
Lian An, University of North Florida Jason Jones, Furman University
James Arias, Georgia College and State Lillian Kamal, University of Hartford
University Bryce Kanago, University of Northern Iowa
Nursel Aydiner-Avsar, University of Utah Leonie Karkoviata, University of Houston
Michael D. Bauer, Economist, Federal Ben Kim, University of Nebraska–Lincoln
Reserve Bank of San Francisco Ruby Kishan, Texas State University–San
David Beckworth, Texas State University Marcos
Emma Bojinova, Canisius College Todd Knoop, Cornell College
Mark Brady, San Jose State University Gregory Krohn, Bucknell University
Michael Buckley, Fordham University Krishna Kumar, Duke University
Susanne Buesselmann, Wayne State Kenneth Kuttner, Williams College
University Susan Laury, Georgia State University
Bolong Cao, Ohio University Jim Lee, Texas A&M–Corpus Christi
Piyaphan Changwatchai, University Jialu Liu, Indiana University–Bloomington
of Utah Gregory Lubiani, Southwest Tennessee
Adhip Chaudhuri, Georgetown University Community College
May Collins, Mira Costa College Guangyi Ma, Texas A&M University
William Craighead, Wesleyan University Karen Maguire, University of Colorado–
Chetan Dave, New York University–Abu Boulder
Dhabi John McArthur, Wofford College
Stephen Davis, Southwest Minnesota State Shahriar Mostashari, Campbell University
Dennis Debrecht, Carroll University Kanda Naknoi, Purdue University
Justin Dubas, Texas Lutheran University Esen Onur, California State University–
Dennis Edwards, Coastal Carolina University Sacramento
Noha Emara, Barnard College, Columbia Biru Paksha Paul, State University of New
University York at Cortland
Merton Finkler, Lawrence University Nate Peach, Colorado State University
Layton Franko, Queens College William Perkins, Manhattanville College
Lise Frulio, Northwest Arkansas Community Reza Ramazani, Saint Michael’s College
College John Rasmus, Diablo Valley Community
Tim Fuerst, Bowling Green State University College
Sarah Ghosh, University of Scranton Luisa Blanco Raynal, Pepperdine University
Satyajit Ghosh, University of Scranton Malcolm Robinson, Thomas More College
Chris Gingrich, Eastern Mennonite Jack Russ, San Diego State University
University Subarna Samanta, College of New Jersey
Vance Ginn, Texas Tech University Mike Sandberg, University of Florida
Roy Gobin, Loyola University Amy Schmidt, Saint Anselm College
Nick Gomersall, Luther College Andrei Shevchenko, Michigan State
Michael J. Gootzeit, University of Memphis University
Steven Greenlaw, University of Mary Fahlino Sjuib, Framingham State College
Washington Rachael Small, University of Colorado–
Alan Gummerson, Florida International Boulder
University Bill Smith, University of Memphis
Marwa Hassan, Rutgers University Issoufou Soumaila, Texas Tech University
Scott Hegerty, Canisius College Mark Steckbeck, Campbell University
Kolver Hernandez, University of Delaware Herman Steckler, George Washington
Kim Huynh, University of Indiana University
Miren Ivankovic, Anderson University Paul Stock, University of Mary Hardin–
Brian Jacobsen, Wisconsin Lutheran College Baylor
xlii preface
Ellis Tallman, Oberlin College Grace Yan, Oklahoma State University–Tulsa

Wendine Thompson-Dawson, Monmouth Chenygu Yang, University of Central Florida
College Mark A. Yanochik, Georgia Southern
Jay Tontz, Diablo Valley College University
Raúl Velázquez, Manhattan College Janice Yee, Worcester State College
Bhavneet Walia, Nicholls State University Elizabeth Anne York, Meredith College
Anne Wenzel, San Francisco State University
Class Testers:
Michael Buckley, Fordham University Susan Laury, Georgia State University
Michael Carew, Baruch College of CUNY John McArthur, Wofford College
Jim Eaton, Bridgewater College Shahriar Mostashari, Campbell University
Jean Gauger, The University of Tennessee Kanda Naknoi, Purdue University
Aaron L. Jackson, Bentley University Ellis Tallman, Oberlin College
Jason Jones, Furman University Victor Valcarcel, Texas Tech University
Finally, I want to thank my extended family, who enable me to be so productive because

they give me so much joy: my wife, Sally; my two children, Matthew and Laura;
Matthew’s wife Kim; my goddaughters, Alba, Glenda, and Norma; their husbands,
Isaac, Andy, and Sergio; and their six children, Robbie, Sophie, Adrian, Sam, Sarah, and
Olivia.
I dedicate this book to my mother, who was still sharp as a tack and a lot of fun
when she passed away in 2012 at age ninety-one.
Frederic S. Mishkin
About the Author
Frederic S. Mishkin is the Alfred Lerner Professor of Banking and Financial
Institutions at the Graduate School of Business, Columbia University. He
is also a research associate at the National Bureau of Economic Research
and past president of the Eastern Economics Association. Since receiving
his Ph.D. from the Massachusetts Institute of Technology in 1976, he has
taught at the University of Chicago, Northwestern University, Princeton
University, and Columbia. He has also received an honorary professorship
from the People’s (Renmin) University of China. From 1994 to 1997, he was
executive vice president and director of research at the Federal Reserve
Bank of New York and an associate economist of the Federal Open Market
Committee of the Federal Reserve System. From September 2006 to August
2008, he was a member (governor) of the Board of Governors of the Federal
Reserve System.
Professor Mishkin’s research focuses on monetary policy and its
impact on financial markets and the aggregate economy. He is the author
of more than twenty books, including The Economics of Money, Banking,
and Financial Markets, Tenth Edition (Pearson, 2013); Financial Markets and Institutions,
Eighth Edition (Pearson, 2015); Monetary Policy Strategy (MIT Press, 2007); The Next
Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems to Get
Rich (Princeton University Press, 2006); Inflation Targeting: Lessons from the International
Experience (Princeton University Press, 1999); Money, Interest Rates, and Inflation (Edward
Elgar, 1993); and A Rational Expectations Approach to Macroeconometrics: Testing Policy
Ineffectiveness and Efficient Markets Models (University of Chicago Press, 1983). In addi-
tion, he has published more than 200 articles in such journals as American Economic
Review, Journal of Political Economy, Econometrica, Quarterly Journal of Economics, Journal
of Finance, Journal of Money, Credit and Banking, and Journal of Monetary Economics.
Professor Mishkin has served on the editorial board of American Economic Review
and has been an associate editor at Journal of Business and Economic Statistics, Journal of
Applied Econometrics, Journal of Economic Perspectives, and Journal of Money, Credit and
Banking; he also served as the editor of the Federal Reserve Bank of New York’s Economic
Policy Review. He is currently an associate editor (member of the editorial board) at five
academic journals, including International Finance; Finance India; Review of Development
Finance; Borsa International Review; and Emerging Markets, Finance and Trade. He has been
a consultant to the Board of Governors of the Federal Reserve System, the World Bank,
and the International Monetary Fund, as well as to many central banks throughout
the world. He was also a member of the International Advisory Board to the Financial
Supervisory Service of South Korea and an advisor to the Institute for Monetary and
Economic Research at the Bank of Korea. Professor Mishkin was a Senior Fellow at the
Federal Deposit Insurance Corporation’s Center for Banking Research and was an aca-
demic consultant to and serves on the Economic Advisory Panel of the Federal Reserve
Bank of New York.
xliii
1
Part
Introduction
Chapter 1
The Policy and Practice of Macroeconomics
Chapter 2
Measuring Macroeconomic Data
Part
1 Introduction
We begin with an introduction to the study of macroeconomics. Chapter 1 de-

scribes the questions that macroeconomists seek to answer and the data they
seek to explain, raising key policy questions that will be the focus of the remain-
ing chapters of this book: How can poor countries get rich? Is saving too low? Do
government budget deficits matter? How costly is it to reduce inflation? How can
we make financial crises less likely? How active should stabilization policy be?
Should macroeconomic policy follow rules? Are global trade imbalances a dan-
ger? Chapter 2 examines how economists define and measure the most important
macroeconomic data.
In keeping with our focus on key policy issues and the techniques policymakers
use in practice, we will analyze the following specific examples in Policy and
Practice cases:
■ “Can GDP Buy Happiness?”
■ “Policy and Overstatements of the Cost of Living”
The Policy and Practice of
Macroeconomics 1
Preview
What are your career plans after graduation? Many factors beyond your grades and choice
of a major affect the ultimate path you take. When you graduate from college, will jobs
be plentiful or will a high unemployment rate (as occurred in the aftermath of the 2007–
2009 recession) make it a challenge to find work? Will overall prices be rising rapidly, so
you will need more money to pay for your expenses next year? Will the value of the U.S.
dollar decline so that it will be more expensive to travel abroad? Should you worry about
the current high government budget deficits? Jumping ahead, will the economy grow rap-
idly over the next thirty years, so your children will be better off than you? We will address
the economics underlying the answers to these questions throughout this book.
In this chapter, we set the stage for your exploration of the policy and practice of
macroeconomics. We start the chapter by examining what macroeconomists do and what
data they seek to explain. We then preview the policy issues that we explore throughout
this book.
The Practice of Macroeconomics

In formal terms, macroeconomics is the study of economic activity and prices in the
overall economy of a nation or a region. Macroeconomic research draws heavily on
microeconomics, which looks at the behavior of individual firms, households, or mar-
kets.1
The Process: Developing Macroeconomic Models

Macroeconomists try to explain how the overall economy works by using an economic
theory, a logical framework to explain a particular economic phenomenon. Economic
theory involves developing an economic model, a simplified representation of the
1We will explore the microeconomic foundations of macroeconomics in Chapters 18 to 20 of this book. 3
4 Part one • Introduction
e conomic phenomenon that takes a mathematical or graphical form. The development

of an economic theory or model typically involves five steps:
1. Identify an interesting economic question. For example, a macroeconomist
might want to understand why the unemployment rate rises or falls over
time, or why workers’ wages in real terms (in terms of the goods and ser-
vices they can actually buy) rise more rapidly during certain periods, but
not others.
2. Specify the variables to be explained by the model, as well as the variables
that explain them. A variable that a macroeconomist wants to explain is
referred to as an endogenous variable, because it is explained inside the
model he or she is building (and thus has the endo prefix). She would then
identify a set of factors, called exogenous variables, that are used to
explain the endogenous variable, but are taken as given and thus are viewed
as determined outside the model. (This is why they have the exo prefix.)
For example, in explaining the endogenous variable (the unemploy-
ment rate), the macroeconomist might specify consumer optimism or
government spending as exogenous variables that are taken as given. Or
if he or she were interested in explaining real wage growth, the endog-
enous variable, the macroeconomist might choose the rate of technological
progress or the power of unions as the exogenous variables. The schematic
diagram in Figure 1.1 illustrates the relationship between endogenous and
exogenous variables in an economic model.
3. Posit a set of equations or graphical analysis to connect movements in the ex-
ogenous variables to the endogenous variables. For example, we might create
a formula showing how, all else being equal, a 10% increase in government
spending would change the unemployment rate. This formula is our model.
4. Compare the conclusions of the model with what actually happens. For
example, if the model is designed to explain the unemployment rate, we
Figure 1.1
Variables in
Macroeconomic
Models Exogenous Variables
Endogenous Variables
The model is a set (consumer optimism or MODEL
(unemployment rate)
of equations or a government spending)
graphical analysis that
explains movements
in the endogenous
variables—variables
that are explained by
the model—as a result
of changes in the exog-
enous variables—given
factors not determined
by the model.
Chapter 1 • The Policy and Practice of Macroeconomics 5
would compare the model’s predictions to actual unemployment data in

prior years. If the conclusions do not match this historical data, return to
step 2 and change the model.
5. If the data are well explained, use the model to make further predictions,
say on where the unemployment rate will head a year from now, and
suggest policies to lower it.
The iterative process of comparing a model to actual data, making improvements
along the way, raises new economic questions and advances knowledge in macroeco-
nomics. We will look at the interaction of data and macroeconomic models as we proceed
through this book, highlighting how the field of macroeconomics has evolved over time.
We will also see how well macroeconomic models explain the data by looking at numer-
ous applications featuring the U.S. and world economies throughout every chapter.
The Purpose: Interpreting Macroeconomic Data

Macroeconomists, and in turn macroeconomic models, focus in particular on three eco-
nomic data series: real GDP, the unemployment rate, and the inflation rate. We look at each
in turn.
Real GDP. Real Gross Domestic Product (GDP) measures the output of actual
goods and services produced in an economy over a fixed period, usually a year. As we
will see in Chapter 2, real GDP also equals the total amount of real income of every per-
son and firm in the economy.
Figure 1.2 shows real GDP per person in the U.S. economy from 1900–2013 and has
two important attributes. (To account for changes in the purchasing power of a dollar,
we treat all goods and services as if they were sold at prices from the year 2011.) First,
Real-time data
Figure 1.2
$50,000
GDP per capita (Constant U.S. dollars, 2011)
U.S. Real GDP Per

Capita, 1900–2013 $45,000
Due to business cycle $40,000
fluctuations, real GDP $35,000
per person has grown
substantially but not $30,000
smoothly, over time. We $25,000
represent recessions
with the shaded areas. $20,000
Depressions are severe $15,000
declines in real GDP,
the most notable being $10,000
the Great Depression $5,000
(1929–1933).
$0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Year
Sources: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/; and for data before
1960, Maddison, Angus. Historical statistics. http://www.ggdc.net/maddison/
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Plows, and in which the Vessels are to be placed, which hold the
Metals that are to be maturated by the Spirit of Salt, and which have
a continual heat, whereby the never-ceasing coction is holpen from
the Tower that contains the Coles. Now see that you make all things
cleverly and well proportioned, whereby that the Fire may be well
and commodiously governed, and may be conserved for twenty four
hours at least, without any looking too or medling with, as may be
seen by the now described Figure.
The Vessel, in which the Spirit of Salt, with the Metal, is to be
exercised (or laboured) with a daily Coction, must be made of such
matter as doth not flie with the heat of the fire, nor is not eaten with
the sharpness of the Spirit, (but) such as may be seen in my
Laboratory, and will for the most part dure and hold the Spirit of Salt
a whole year without breaking.
All things being ready and fitted, the Countrymans Belly is to be
filled with Coals up to the Neck, and his Head covered with a Cap,
that the Fire may not find any out-let, save by the lower holes,
through which, the heat may find an entrance into the adjoined
Furnaces; and as for the Vessels, they are to be filled with the Spirit
of Salt, and with Metals fitted for this Operation, and to be covered
with their Alembicks, that the Spirits which ascend in the boiling may
be received and conserved. When all the Spirits of the Salt are come
over, they are to be again returned back upon the dried matter in
the Cucurbit, and are to be agen drawn off by distillation. This
operation and cohobation being often repeated, doth ripen and fix
the spiritual Silver and Gold, whereby it becomes Corporeal: But yet
the Spirit of Salt alone is not able to give Gold, but ripens Silver
onely, but by the addition of other Salts, it will give Gold too. And
even for the fixation of Silver, common Salt may be also added to
the Spirit of Salt, that so the Spirit of the Salt may be made strong in
the digestion; yea and in time so very strong, as to fume even in the
cold Air, and therefore a little water may be also added besides the
Salt.
Hence it comes to pass, that in one days digestion six pounds of
Spirit of Salt will give seven pounds of the same; unto which, if you
again add one pound of Water, and one pound of Salt, you shall
have eight pound of Spirit of Salt: which by the addition of another
pound of Salt, and one pound of Water more, it may be farther
augmented; insomuch that the Spirit of Salt, by a continually-
repeated addition of Water and Salt, gets a perpetual encrease, and
the Metal is so far from being at all hindred in its maturation, as that
it is daily ripened more and more. For the Agent and Patient are
continually encreased, and become bettered both in quantity and
quality, which verily is a most excellent work, and never so
manifestly described by any body as by my self.
But that I may be yet better understood by every one, I will here
adjoyn a way which every one may imitate, and which teacheth
how, by the Spirit of Salt alone affording not Gold but Silver, the said
operation may be instituted with Copper.
You must take care to have a Vessel made either bigger or lesser,
of such matter as the Spirit of Salt cannot spoil or prey upon; And
pour thereinto as many pounds of the Spirit of Salt as it will well
hold, and as many pounds as there be [of Spirit,] so many ounces of
Copper-plate must you put in, and to them add twice as many
ounces of Salt, so that to one ounce of Copper there may be two
ounces of Salt. The Spirit of Salt being drawn off even till the Copper
and Salt be dry, it will be stronger and more in quantity, because,
from the adjoyned Salt, it hath acquired to it self an encrease and
greater Virtues. Pour this Spirit agen upon the Copper, which in the
first distillation was wholly dissolved up; and boil the Spirit of Salt
over the fire, that the Copper, together with the Salt, which was not
carried over by the Spirit in the first distillation, may be again
dissolved.
The Furnace being cool’d, Take the glass out of the Sand, and
pass the Spirit of Salt with the dissolved Copper through Cap-paper,
and wash the white Calx that remains in the Paper with water, dry it,
and melt it with a fix Lixivial Salt, and you shall find as much pure
Silver, nay, even somewhat more than the Copper had in it by its
own nature. Put the green filtred Solution agen into the Cucurbit,
being first well wash’t; of which, if there be six pounds, add
thereunto one pound of Salt, and half a pound of Water, that so
there may be seven pounds and an half, provided the Cucurbit will
contain so many pounds, if not, then put the less matter therein.
Then being placed in Sand, draw off the Spirit of Salt from the added
Salt, even to dryness, and as much increase as you find it have
above six pounds, lay it by, and add as much water to these
remaining six pounds, which you must again put upon the dry
matter in the Cucurbit, and then agen distill it off till the said matter
be dry, and repeat the same Operation again by pouring on and
distilling off. If the Spirit of Salt be augmented in quantity one
pound, then put more Salt into the Cucurbit, and agen augment the
six pounds of Spirit of Salt by the addition of Water, and repeat the
pourings on, and drawings off after the aforesaid manner, always
removing at each Distillation, the increase that is over and above six
pound: and renewing the apposition of more Salt, after that the
former is drawn off, untill you shall have gotten in the fifth, sixth,
seventh, eighth, or tenth Distillation as much Spirit as you at first
took, to begin your Distillation, [which was six pound.] Now all the
operation consisteth in this knack, namely, that you so operate, as
that nothing flies away in fume, for all the encrease ariseth from the
Salt and Water which you added thereunto. When you have gained
thus much, you may (without adding any more new Salt) pour on
the Spirit of Salt several times upon the Salt which is left remaining
in the Cucurbit, and agen draw it off so often thencefrom, untill it
hath brought over with it self almost all that Salt. Which [Salt] being
almost wholly changed by the Spirit of Salt that was poured into the
Cucurbit, Dissolve up the remaining Mass of the Copper and Salt,
and the Sand being cold, take out your Cucurbit, Filter the Spirit
through Cap-paper, and wash the white Powder left in the Paper, and
dry it, and melt it as afore with a Lixivial Salt, and you shall have as
much pure Silver as the Spirit of Salt was able to fix, of the Copper,
in such a time. Then put this green Spirit of Salt into the Cucurbit
together with more new Salt, and repeat the said labours ten or
twelve times, and the Spirit of Salt will be always encreased and
rendred more strong, and the Copper will agen yield forth Silver.
This Labour, you may at your pleasure, continue as long as you
list, for you will always get some Silver, and have an encrease of
Spirit. For both the Agent, viz. the Spirit of Salt, and the Patient, viz.
the Copper doe encrease both as to quantity and quality.
But it may be demanded, Whenee that Silver comes? That which
gave forth it self the first time we impute not unto the Spirit of Salt,
as if by it made, no! but we say that it was in the Copper before,
and was melted out of the Oar, together with the Copper, for this
may well be. For there’s no Copper to be found which does not hold
some Silver hidden in its belly: and though the Refiners have as
accurately separated it as they could, yet nevertheless we doe
conclude that that first Silver separated in the first Operation, was
what was left of the Oar in the Copper, and remained unseparated
by the Melters [or Refiners] therefrom, and was not made by the
Spirit of Salt, but onely separated. And the Spirit of Salt being in its
nature an enemy to Silver, does not dissolve it. But whence then did
that come, which offered it self unto us the second, third, and fourth
time; whereas in the first Solution, all the Silver was clearly taken
out, and none at all left therein, but was all of it separated by
filtration? What shall we here say, or indeed how shall we dare say
otherwise, but that we believe and confess, that the Spirit of Salt did
by its operation make the same of the Copper. Nor is there any
reason why this should seem so very strange unto us, forasmuch as
yearly, in the Earth, all Copper is naturally turned by Salt into Silver,
and not onely Copper, but all the other Metals were at first, Salts:
not such indeed as we use about our Cookery in the Kitchins, but
such as are impregnated by the Sulphureous Stars [or
Constellations.]
But forasmuch as we doe at present treat onely of Copper, we doe
not therefore meddle with the rest of the Metals: for very rarely is
Copper digged out of the Earth but it hath Vitriol therein, or, in
defect of Vitriol, a Sulphur salted with a vitriolate salt. For any sort of
Sulphur being burnt, and its fatness flaming, the sharp Salt is
released, and passeth away in fume, resembling the tast, of the fiery
Oil of Vitriol, and is captivated [or caught] in the great Alembick
under which the Sulphur is burnt. This sharp Oil supplies the place of
an Agent as to the Minera’s or Oars, in the Veins of the Earth; and
doth more and more ripen the Minerals and Metals, but exceeding
slowly: for Nature doth scarce attain to that limit in a thousand
Years, which Art doth in a few Months time. For there are no
impediments to obstruct the operativeness of our Agent, such as are
the Stones, Flints, Sands, and various Earths which frequently occur,
and are much abounding in the bowels of the [Metallick] Veins:
insomuch that it can discharge its Operations freely, and without any
Impediment at all: and besides too, we use our external fire by
which we help this our Agent, and strengthen its virtues, and keep it
in a continual action.
By all this discourse may every one see, that when we speak of
ripening Silver out of Copper by the Operations of the Spirit of Salt,
it is not contrary to nature, but altogether agreeable with the same.
But now we doe not say that any one will suddenly become rich by
this Labour, done with the Spirit of Salt and Copper, but we have
described this Operation in this place, for this end, namely, that
hereby the possibility of the thing may be learned, and that there
may be good ground to believe, that even this too is most true, viz.
when we write that by such or such an Agent, corroborated or
fortified with such or such Subjects, and placed in such-like
Digestions, Gold may be extracted as well as Silver out of the
meaner Metals, which how little soever there be of, may
notwithstanding prove profitable. For having once made onely some
pounds of Spirit of Salt, you will not need to make any more anew,
for in the digestion and maturation of the Metals, it will daily
encrease, and that in a plentifull manner, and that too without any
considerable costs, seeing that the Salt it self, which is to be added,
is likewise cheap enough. If you make your Cucurbit of pure Silver,
(for the Spirit of Salt will not work upon that) and digest your
matters therein, you need not then stand in fear of the breaking of
Glasses: Besides too, you may always let such a made Vessel lie in
the Furnace, and as soon as ever the Spirit is drawn off, you may
presently put it on agen, nor is there any need of your waiting so
long, and ceasing from the work till the Vessel cool. If therefore a
Tower to put the Coals in (as afore) be added to that Furnace, or
Furnaces, then is it a true Countrey Farmer, or Tenant, for the
sustaining of whom, there will need no other charge but that of
Coals, and yet notwithstanding he gives you a perpetual gain
without labour, cost, and trouble. Nay more, if we do but rightly
weigh the business, we shall find that the daily encrease of the Spirit
of Salt in these labours, is easily sold for more Money than the Coals
will cost, so that all that Gold and Silver which is gotten out of the
Metals, doth offer it self unto us for nothing. Besides, such kind of
Metals may be taken for this Operation as are wont to yield more
Silver and Gold than Copper, and the plentifulness thereof will be yet
more, if several such kinds of Metals are joyned together and so
dissolved, and digested, in which operation they better one another
by a mutual action; for one supplies what another wants, and
likewise from another, are those superfluities which it has in it, taken
therefrom: so that (as we said afore) the mutual melioration of those
Metals may be set on foot and promoted, as it were without any
cost, and by a very little labour.
Whosoever he be therefore that has the knowledge and
experience of the nature and property of the Metals, which they are,
that have a correspondency with each other, and that love to better
each the other; and is not ignorant what Agent is agreeable to Gold;
such a one I say as this is, will commit unto his Countrey Tenant the
care of Weekly and Monthly paying the due Rent, and will be able by
this means to serve God his Creator without wicked Usury; to do
good unto his Neighbour, to extricate himself out of that Diabolical
Fellowship, of the impious and the great crew of evil Men; and to
lead his Life in Tranquillity and Quietude; which verily is a great and
singular gift of God, unto any one that can arrive unto such a
knowledge.
But yet no Man hath any reason to perswade himself, should he
be a Master of this Art and Science [here shewn,] that he shall be
able daily to separate great heaps of Gold out of the more imperfect
Metals, whereby he may be enabled to lead a vicious Life. No, for
my endeavour shall (in the first place) be, not to make any wicked
Man partaker of this Art.
And secondly, the whole business consisteth in the blessing of
God, as we find it Written, Paul hath planted, and Apollo Watered,
but God hath given his Blessing: For without this Blessing, all our
Labour is but in vain: And this the Prophet David doth likewise
testifie, saying, In vain do ye rise up early, and being loaden with
many cares, go to Bed late, and eat your Bread with troubles: For
unto them whom God is favourable doth he bestow his gifts even
while they are Asleep. Moreover St. Paul saith, It is not of him that
wills, nor of him that runs, but of God that sheweth mercy. And
therefore a wicked Man, though he should possess so great a thing,
yet would he not do any good upon it, if he wanteth Gods Blessing.
Besides, I do not here bring forth my little Countryman upon the
Stage, as if he could help any one unto huge Treasures; no, but
onely as one that can bestow so much as may suffice, honestly to
live. Unless haply a Man should light upon rich Veins and metalline
Oars, which should abound with much corporeal Gold, and so by this
means should yield great Treasures. Now so much cannot be lookt
for, from such Metals as have in them but a spiritual Gold onely,
unless the true weight be found, and that there be gotten the
knowledge of those Metals which have a great affinity with each
other, and which being joined together yield forth Gold. Otherwise
you must not expect ought else from this Operation save an honest
and moderate profit.
But now, as touching what Metals they are that have such affinity,
and what the true proportion of the weight is, no body hath any
reason to enquire of me, for I do not as yet profess my self an
expert and absolute Artist in this matter, for sometimes I have a very
gainfull success of my trials that I make, and sometimes agen I get
less.
I was willing therefore to shew the way here, of ripening the
meaner Metals by the help of Salt, and that too in a manner without
any costs: which way of so doing being by me laid open, may suffice
for this time, nor did ever any reveal it before me (I speak it without
boasting) or produce it unto publick view in so open a manifestation
as I have done.
And now if this separation should be used about the fixed Gold
onely which lies hidden in the Oars and Metals, yet mought great
profit be thereby gotten in all places; for there is no place in the
World in which there are not to be found such Earth, Sand, and
Stones as contain in them corporeal Gold, which may be extracted
by the afore prescribed way without any costs at all. But here is to
be observed that those things which I have written, and clearly
demonstrated concerning such separatory Operations in the third
part of the Prosperity of Germany, are to be agen read over, and
well lookt into.
Moreover, this is also to be known, that this maturation if
instituted by the dry way, brings more profit than if done by the
moist way; for in the dry way the Agent is more holpen than in the
moist way, in which there is always plenty of moisture. But however,
both ways namely the dry way, and the moist may be done with one
and the same Fire, nor will the cost be any more than if the moist
way were made use of alone by it self.
For that Tower wherein the Coals are, and which is to keep the
Spirit of Salt in perpetual digestion, and to heat the adjoined
Furnaces, is always bright hot at the Grate, upon which [grate] if a
cementing Vessel filled with Salt and Metals be placed, there will
then be even thence as much profit as by an adjoined Furnace, and
so by the Fire of one Furnace, and by the self same labour and cost
is a double Operation performed, and a continual rent may be
expected from the double Countryman.
You must likewise note, that there is a great difference of Salts,
and that one Salt is more fit for this labour, and another for that; but
by how much greater the Acrimony is, that the Salt abounds withall,
so much the more potent an Agent it is: insomuch that it is of great
concernment for a Man to know how to concentrate the moist Fire or
Agent, concerning which Concentration there is no need of
mentioning any thing in this place; forasmuch as I suppose that
these things which are at present spoken are sufficient enough.
Moreover I would have the Son of Art know, that the Salt of the
Macrocosm or of the Ocean, which we have taught the making the
Spirit of, is nothing at all so efficacious as that which is gotten out of
the Microcosm: For whatsoever things are found to be in the
Microcosm or greater World, the same are likewise in the Macrocosm
or lesser World, namely, Man. But it is not my purpose to discourse
farther of this thing in this place, but will (God so permitting) treat
more at large of the same, if I come to write somewhat of the
nature and signature of the greater World. For hereby great
mysteries may be learned, which omitting to speak more of, I keep
close to Salt and say, that that Salt which comes out of the Ocean or
Sea of Man, or of some other Animal, that is, which is voided out of
the Bladder, is far more fit for the Transmutation of Metals, than that
which is gotten out of the Sea, as being the Bladder of the great
Animal.
The Ancients have called the World the great Animal, and very
rightly, for in its Center it hath a fiery heart by which (as being the
great Animal) it moves it self, and conserves its life, as shall be
Spoken of in another place if God shall permit, for according to the
common Proverb, Man proposeth and God disposeth.
Morien was not ignorant that Arcana’s of great moment lie hidden
in Urine, but hath manifestly signified it. For when he had prepared
the Tincture for King Calid, he wrote upon the Vessel in which it was,
these words, He that carries all things with him, needs not any
others help. And having so done, he silently betook himself unto his
Cell. But he had said before unto the King, In thee O King! the
Medicine is, by which words, he meant Urine. For out of Man’s Urine
may a fix Stone be made, which shall be manifested in other places.
Furthermore this likewise is to be here known, that it is a most
notable and a true experiment and artifice in Alchymy, that is, in the
true melting of Salt, when the Agent of Salt, and the Patient, or
Metal, are so thoroughly conjoined and mixed, as that the Agent is
disperst throughout the Patient, that so the Patient may suffer the
more, and consequently that that Patient Metal may be the sooner
ripened and fixed. When a Flock of Sheep being in the Fold, see the
Woolf coming, they are indeed all terribly affrighted, but are not all
bitten and torn, and so a part of them feel the hurt and the other
part remain free. But if the Woolf seizeth upon the Sheep in the
open Field, and that the Sheep are scattered far and wide so that
they cannot possibly flock together, they will certainly suffer more
grievously.
For Example sake, when I would meliorate Lead by means of Salt,

whether by the moist way by Spirit of Salt or by the dry way by dry
Salts, if now I cannot radically conjoin the said Salts and Lead
together, I do but little to purpose, because Lead and Silver, unless
prepared by singular Ingeny and Skill, are not touched upon by Salt
and its Spirit, and so suffering but superficially onely they are able to
resist a long time. But being radically united unto Salt by the benefit
of Art, so as that they cannot be distinguisht from each other, then
they suffer in all their parts and die, which death is their melioration
and life. He that desires to arrive at this Goal, must rise betimes, and
use a most notable diligence, for sloathfulness hedgeth up the way
of coming thereunto: Even I my self am no perfect Artificer, but wait
upon the Omnipotent God, expecting what he will please to bestow
upon me for time to come, and I live content with my present
enjoyments. Thus likewise let another do.
But if now Saturn is to be used after another way and to serve
instead of Earth to receive and multiply the metallick Seed, there’s
no need of dissolving it in Salts, but it will be better to have it onely
swell or puft up in them, and keep in such a positure as Earth is,
conserving the Seed sown therein, in a moderate humidity and in
the temperate heat of the Sun, which way is also a good one and
commodious for the production of good metallick Fruits, and that by
the help of Salt, as the following Process shews, under this title,
namely,
The Fire and Azoth wash Laton.
S ome of the Philosophers have called their Patient Laton, and

their Agent Azoth. But what subject that is which they meant
by the name of Laton there are many Opinions of Authours
concerning it, in whose Writings may be seen, that the greatest part
of them do intend thereby Saturn, but yet not the vulgar: and even
so is it too concerning their Azoth, or Vinegar, that being likewise
diversly accepted. But be it as it will, yet this is certain, that even in
the common Saturn do many abstruse secrets lie hidden, (to say
nothing of the more mysterious Saturn, did we but know how to get
it out.)
All Philosophers do suppose, that the Heart in Saturn is better
than that in Gold it self, and for that reason do they call Lead a
Leaprous Gold, and say, that if it could be mundified by a true
washing, some great matter would proceed thereout of. Many Men
have very much busied themselves about this washing, but yet have
not attained unto ought else, save that they have brought the Saturn
into a white, fugacious, and liquid Body, concerning which labour I
have made mention in this Treatise of metallick Cates and Sawces,
and also in the third Part of the Prosperity of Germany.
In my judgment, the common Saturn is a commodious Earth, for
the reception of a metallick Seed, and for bringing the same unto
multiplication Witness Paracelsus himself who tells us, that Saturn
may be compared to the Earth, for all such things as it seizeth on it
makes like it self, and turns them into Earth, viz. in the common Fire,
for Paracelsus here intends that.
But now, if some metallick Seed be sown in Saturn, as being a
commodious metallick Earth, and that such an Earth and such a
Seed be moistned with a due metallick Water, and be exposed to the
fruit producing and vivifying Sun, the earth together with the Seed,
doth by reason of the moistning caused by the pouring on, or
affusion of the mineral Water, swell up, and become porous, and
receives and conserves the Water, so that the ripening Sun cannot
dry up the Earth, and consequently burn up the Seed. And by how
much the oftner the Earth is moistned with the mineral Water, and
the Sun expelleth the said humidity, so much the speedier doth the
Seed ripen, and attain to his maturity.
For like as the Husband-man when he is about to sow this Corn,
chooseth such a ground, as contains a fat and tenacious mould,
which may not be washt away with the Rain, nor suffer the due
nourishment to be withdrawn from the Seed; for if the Seed be sown
in Sand, a little Rain can easily wash away the Sand and Seed, and
impede the faculty of growth, which in a fat and tenacious Soil is not
wont to happen. For the Water or Rain should but onely moisten the
Earth, that it may not be too closely comprest, but become porous
and admit of the Rains penetrating unto the Seed: which when so,
then is there hopes of the Seeds sprouting, in such a fat Earth which
swells up by means of the Water, and of bringing forth its Fruit.
Even just after the same manner are the metallick Seeds to be
sown, and ripened; and for Example sake, let us take the vulgar and
common Saturn, (well mundified) for that Earth, into which we will
sow such a Seed as having a great affinity with Saturn, loves to be
augmented therein, whereby it may bring forth fruit. And like as the
Seed of any Animal requires an Animal Matrix, as a Field or Earth to
be multiplied in, and hath not any affinity with the common Earth:
Even so likewise doth a metallick Seed require a metallick Earth,
Matrix, or Ground, wherein it may germinate and be multiplied.
Now this multiplication is on such wise made, as is done in the
Animals, by the conjunction of Male and Female, one performing the
office of the Agent, and the other of the Patient. So then, we will
make some trial in this Process which is here annexed, not for the
intent of getting great Treasures thereby, but for the sake of
searching into, and getting the knowledge of Nature; we will take
the Male in the room of the Seed, and the Female instead of the
Ground or Field, and we will try whether or no the Seed will admit of
multiplication.
Let us therefore take the common Saturn for the Feminine Matrix,
and Antimony of the Male-like-seed, which we will sow into its own
Matrix, as Husbandmen are wont to do. I do not gain-say but that
there are other Seeds, and probably better to be found to be
implanted in Saturn, than Antimony is: But yet here I content my
self with this of Antimony, as having an intention of onely shewing at
this present, by what way it may appear that a metallick Seed may
be brought to a faculty or possibility of growth in the Saturnine
Earth. And upon this account for Demonstrations sake of this Labour,
was I willing to use Antimony, it being a masculine Seed of a
Saturnine kind. For common Saturn is usually accounted for the true
first Ens of Lune, and Antimony for the true first Ens of Sol, and they
are in very deed found so to be. For you shall not find any Lead
without Silver, nor any Antimony without Gold; so that I strongly
perswade my self that from those two, there cannot arise ought else
but what is good and profitable, did we but know how legitimately to
compound and handle them. And although I do not profess my self
to know many things, yet will I simply tell you my opinion,
concerning the way which I suppose such a Commixtion and
Maturation may be effected by.
A Philosopher saith thus,

By Gold and Silver you will nothing do,
Unless you use their first Ens thereunto.
The first Entities of both these are Lead and Antimony, the latter
of which, (viz. Antimony,) is not to be admitted in that impure state
that we find it in, unto the former, as unto its Bride or Spouse, but
must first be washed in a hot and sharp Lixivial Bath, that it may
thereby attain to a delicate silvery whiteness, and shine like a Star in
the Firmament; which Antimony thus purged, is called by Paracelsus,
the signed Star.
But yet I would not have any one to think, that I do here mean
the common stellate Regulus of Mars, which would be dissolved in
Spirit of Salt, and would separate it self from the Lead, which ought
not to be: But that signed Star must be so prepared, as not to admit
of being dissolved in Spirit of Salt, for else it will not serve for this
Work. It must be so concreted as if it were so many thin Shells (one
within another,) and so very hard as to be able to cut Glass, and to
strike Fire out of a Flint. This signed Star being so washt, is to be
sown into its own Matrix, and by the solar Heat and fruitfull Rain, to
be promoted and enforced unto growth.
Take of the thus prepared masculine Seed, or signed Star, [A]
parts, and of the feminine kind, [B] parts, melt the signed Star in a
pure Crucible, unto which being molten cast the Woman in, which
being cast in, there is presently made a sweet Conjunction and
Commixtion of them both in that infernal Heat, in which they
familiarly couple together.
The Mass being commixt, is to be poured out of the Crucible
through wet Brooms into cold water, and is to be reduced into
Grains, and so the masculine Seed or Husband will be legitimately
and duely mixt with its Earth or Ground, or Wife: which Earth
together with the Seed which it contains is to be put into a firm
Vessel, which fears not the violent corrosion of the Spirit of Salt, but
in such a quantity as that scarcely a tenth part of the Vessel may be
filled therewithall: Then must there be put thereon as much mineral
Water, namely pure Spirit of Salt, as the Cucurbit can bear, and Fire
is to be put thereunder, whereby the Spirit of Salt is to be again
drawn off, by which Operation, the Earth together with the included
Seed will day by day be refreshed, be moistned and swell up, by
reason of the Spirit of Salt, no otherwise than as if you should
moisten some dry and as it were parched Earth, with Water. For the
Saturn is not dissolved by the Spirit of Salt, but onely swells up, and
becomes foliated, and yet remains whole or entire, nor is it much
unlike unto lovely lookt Talk, which shines with a delicate whiteness:
and therefore the Philosophers say, sow your Gold in white foliated
Earth. Without doubt they meant not common Gold, for then they
would not have said, our Gold, but would have simply said onely
Gold, had they not intended a peculiar Gold, or first Ens of Gold.
N. B. I cannot by any means omit to give you thus much notice,
namely, He that cannot hit upon the manner of preparing the said
signed Star, may endeavour the making of common Saturn aureous,
particularly after this manner, as follows. Extract with Spirit of Salt
out of the Oars or Veins and metallick fugacious Earths, the spiritual
Gold that lies hidden therein, and extract or draw off this Spirit thus
impregnated with Gold from Saturn, which Spirit may by this means
be all agen had, and be used about new extractions. And as for the
Gold which the Spirit extracted, that the Saturn hath imbibed, and
indues it self thereby with a golden nature; which if you imbue or
moisten with many such extractions, that goldenness will, as I may
so term it, grow up or increase in each cohobation, and the Spirit of
Salt it self will become augmented.
If now the Saturn be imbued with a sufficient Portion of spiritual
Gold, it must be reduced by X, or Alkalies, that so the spiritual Gold
may be made corporeal, which will exhibit it self pure unto you, after
that the Saturn shall be driven away on the Test. But yet there is no
need of doing this, seeing it will be better to granulate the Saturn,
and by those repeated cohobations to draw off the Spirit of Salt
agen, being each time impregnated with that spiritual Gold, and so
by this means will you enrich your Saturn with the greater plenty of
Gold. And being so enriched it must be reduced by a fixing X, in my
secret Crucible, which neither suffers any thing to go away in fume,
nor to run out; in which reduction the spiritual Gold and the
fugacious Saturn it self are fixed, so that both Gold and Silver are
found on the Test with great profit, this labour requiring no other
costs save those of the Fire.
This Operation which separates fugacious and fix Gold out of the
Oars and Stones, is far better than that which is made by the
Solutions of Lune and Saturn, described at large in the third part of
the Prosperity of Germany. For here, we do not need either Aq.
Fortis or Vinegar for the Solution of Saturn or Lune, neither need we
the same to get the extracted Gold out of the Spirit of Salt, but
being free from that labour and costs, we [onely] draw off from
Saturn, that Spirit which hath extracted the Gold, which [Saturn]
attracts and holds the volatile and fix Gold that was in the extraction,
insomuch that there is not requisite to this labour of drawing off the
extractions from Saturn, any thing else save onely Coals and Fire.
Add hereunto also, the gainfull encrease which daily comes in by the
addition of Salt and Water, by which the Spirit of Salt is day by day
augmented without any costs.
N. B. When the Spirit of Salt becomes too strong by reason of the
Salt put thereto, that Water wherewith the Oar is washt, after the
first extraction of the Spirit of Salt, [or after it hath first been
extracted with Spirit of Salt] may be made use of [and put thereto]
instead of common Water. For it is somewhat sourish, and hath
likewise a golden nature.
N. B. Praise God, and forget not the Poor, seeing thou art
sufficiently informed and taught by what means thou maist get great
Treasures.
The things I here write, are not for this end, namely, to teach
others how to make great heaps of Gold, but onely to shew them a
way of attaining to a good Medicament, and withall, of knowing and
perceiving by the same labour, that the melioration of the Metals is
altogether possible and certain.
Whoever he be that could attain so far as to bring Antimony and
Lead, as being the first Ens of Gold and Silver, into a certain
Dissolvent, so as that the one would not precipitate the other; then
at length would he have entrance upon the right way, which leadeth
unto great things, like as also Gold and Silver being dissolved in one
and the same Menstruum gives beginning to things of great
moment. I dare affirm therefore, that he that can reduce Gold and
Silver, or Antimony and Lead, with Salt, into an agreement, hath
opened a most strong Gate which leads unto a great Treasure; for
then the Patient must suffer even unto death, and must die, out of
whose dead Body, new and living Bodies do afterwards come forth.
Although I have often told you in my Writings that Gold has no
greater enemy than combustible Sulphur, and that nothing is more
inimicitious to Silver than Salt, and nothing more displeasing to
Mercury than a strong Lixivium, and that amongst these contraries
there is a perpetual Antipathy so long, untill they are constrained by
Art and Skill to become friends and mutually to embrace each other:
yet notwithstanding; this will not be so easily fesible by every prating
Boaster, and that makes a great noise by his lofty vapouring
speeches; no, but for the sake of these very Men, are such great
Arcana’s justly and deservedly wrapt up in darkness, and indeed ’tis
fit they should so be.
Moreover if there be required a great suffering, ’tis necessary that
both the Gold and Silver, as being Male and Female, should suffer
together and not barely the one or the other apart: for hereby this
Regeneration will be made so much the nobler and the more
magnificent. For Example, make a Circle, and cut or divide it with
Diameters crosswise [or at right Angles through the Center] so that
the extreams of the Diameters which divide themselves in the middle
or central point of the cross may touch the Circle, and that of those
four extreams [or Semi-diameters] one may touch above, and the
other beneath, and the other twain may reach, one to the right side,
and t’other to the left. Place the Gold in the uppermost extream
marked with the letter A, and his enemy, namely Sulphur, in the
lower extream, which the letter C, demonstrates. In like manner
place Silver on the left side of the Gold, at the letter B, and its
enemy, viz. Salt on the right side marked D, and you will see how
aversly these enemies behold each the other. The Sol looking about
him espies his capital enemy, Sulphur, directly opposite unto him,
and hath Lune at his left side, and Salt at his right; and very willingly
would he enter into friendship with Lune, and Salt which are joyned
at his side, if they but would, or indeed could. But he honours not
his capital enemy Sulphur, with so much as a look. The Lune placed
by the side of the Sun, does not permit the Salt to joyn it self with
the Gold. For when the Salt is with the Sol, it clearly hinders the
Lune from associating it self with the same. Nor can it possibly be
that Salt, Lune and Gold should enter into a thorough familiarity.
Thus too is it with Lune, who hath her capital enemy diametrically
opposite unto her, and very willingly would she enter into friendship
with both her neighbours, viz. Sol and Sulphur, if they were not such
great enemies (to each other,) and refused this familiarity. For if
Lune associates unto her self the Sun, then Sulphur denies to come
into the society. If she admits the Sulphur as her companion then,
then Sol is excluded, as abominating the friendship with his enemy
Sulphur. Much less therefore can Lune be the companion of them
both together. See the Fig. in the Book of Dialog.
But now if the Gods please, that these four capital enemies,
should unite in one sociable amity, and that wonderfull regenerations
should arise from this new familiarity, (then) do they command
Vulcan to heat in the Fire this Circle comprizing those four capital
enemies, thus constituted in the four aforesaid extreams, and
casting such hatefull looks upon each other, and yet not knowing
how to escape out of the Circle, and to press them together more
and more with his Hammer by little and little, untill all four being
driven into one mass, do come together into one body, which body
doth then obtain a power of reconciling all enemies, and of effecting
great matters.
By this here spoken may any one easily conjecture, what great
suffering there is in this Conjunction, and what great streights do
afflict these enemies, when each of them must thus against their will
enter into friendship with his capital enemy. Verily we find them to
be such sufferings as have not their like again, and therefore do they
produce to light, such great and such wonderfull regenerations. Now
whatsoever it be that is exercised in but a small suffering, the same
doth admit of but small emendation.
The greater the suffering, the greater the melioration, so that that
affliction which brings with it even death it self, brings with it also so
much the more noble and magnificent Regeneration and
Resurrection. He that suffers not in this World, shall not have the
Crown put upon him after his Resurrection. By how much the
greater and more innocent the suffering and affliction of this life is,
so much the greater, and fairer a Crown may be expected in the
other World.
The Grape is prest so long, till it be rid of all its juice, this juice
doth indeed bring a sweet and pleasant delightsomness unto mortal
man, but the Grape it self which the juice is prest out of, ceaseth to
be a Grape, and perisheth through defect of juice, and passeth into
nothing. But unto the noble Vine, hath God given this benefit, that it
yearly bears not barely one but many Grapes together: All which
being pluckt off, it doth nevertheless produce the following year no
fewer, but rather more Grapes; and still remains a blessed and
fruitfull Vine, because it is furnisht with roots and fertile Boughs. On
the contrary, they that have devoured the good and sweet juice
themselves, remain always hungry and thirsty, and that for this
reason, because they guzle down the juice too new and fresh,
whereby their Bellies swell, and they receive no nutriment
therefrom.
This is a thing certain and undoubted, that the bodies of the
Metals become by suffering and dying far more excellent and more
noble. He therefore that knows that the patient is to be subjected
unto its own agent, and doth also understand by what way they are
to be conjoined, will never labour in vain, but will reap the wished
reward of his pains.
When the agent doth touch onely the superficies of the patient,
and penetrates not into its heart or root, there will verily be but a
very little good done, save onely this, viz. That the Agent being afore
rendred aureous, is able to give unto its patient also a golden
nature, and to bring the same to an aureous degree, and to bestow
upon it the perfection of Gold: but that melioration which is done
onely by it self proceeds on very slowly.
As concerning the manner of enduing the Spirit of Salt with an
aureous nature, that so it may the sooner render its patient a
partaker of golden virtues, we have spoken of that already, and
demonstrated it clearly enough; he that does not understand, we
cannot help him any other way.
N. B. When the Eagle, the Servant of Jupiter, hath with his beak
and talons pluckt out the coagulated beams of the Sun out of the
Cliffs and Rocks, and brings them unto Jupiter, he is so very
bountifull, that he sends down the same unto us by the Rain, which
is of so much efficacy, as that all the Herbs upon which it falls are
bettered, and the martial, venereal, saturnine, Lunar and mercurial
Herbs do put on the golden nature of the Sun; so efficacious is the
golden Rain of Jupiter, if the Eagle hath first brought unto him the
coagulated rays of the Sun.
And that I may be the better understood, and that it may be
known, that the Melioration of Metals may be accomplished by a dry
Agent, full as well, yea and better, and more profitably than by a
moist Agent; I have judged it a thing worth while to adjoyn the
following Process under the Title of the Great Country Farmer.
And let the studious Artist know, that the amending of the Metals
by the dry way, by the operation of dry Salt, is far more easie, and
may likewise be dispatcht in a greater quantity, than is wont to be
done by the moist way: and that there is nothing required to this
operation save Salt and Coals, be the Metals that are to be fixed,
even what they will.
For Example, if a man be desirous to fix Saturn, or to procure unto
it a Silvery nature, there needs not pure Lead be taken for this work,
seeing he may have the Oar or Vein thereof for much less price; and
indeed there is some that is a wild and sulphureous Oar, which yields
not, in the melting, any good Lead, and may be had in great plenty
in some places of Germany that I know of, for a very small price, or
rather for none at all. Such a wild Oar of Lead as this is, which yields
neither good Lead, nor is fit for the Potters to glaze their Pots
withall, by reason of its hard fusion, doe I chuse for my operation,
not onely because it costs less than other such Oars of Lead doe,
but for this reason too, because it hath store of Sulphur, and fit
enough for fixation.
This Vein or Oar doe I bring into small Powder, and mix as much
Salt thereto as need requires, then cast it in upon the Coals, in such
a Furnace as I have described to make store of Spirit of Salt in: The
Salt and the Sulphur exercising their vehement or powerfull virtues
upon the Lead, causeth it to be afflicted with terrible dolours,
insomuch that part thereof ascendeth on high [or sublimeth] with
part of the Salt, and betakes it self into Receivers fitted on for that
purpose. In which sublimation, the Salt and the Lead ascend in a
spiritual manner, and contrary to their will, suffer spiritually, and so
are constrained to enter into friendship, finding a place of quietude
in those cold Receivers, and there setling together. The residue of
the Oar, and part of the Salt being burnt up, and emitting no more
flores, but falling down through the Grate like Ashes, more new or
fresh Coals must be put into the Furnace, and new matter must be
thrown thereupon, as afore; and this Labour is to be continued so
long, as it shall please any one to follow it. Now by this, the Saturn
is far more vehemently afflicted, than in the moist way by the Spirit
of Salt; And if unto the Oven [or Receiver] receiving the fume, and
in which the flowers of the Salt and Lead settle, there shall be
applied yet several Receivers, there will then be therein caught store
of Spirit of Salt, which being rectified, may be agen made use of in
the moist way. The flowers being taken out of the Oven or Receiver
into which the fume goes, are to be agen thrown in upon the live
Coals in the Furnace, that they may suffer anew and be sublimed.
After that they are all sublimed again on this wise, they are to be
agen taken out of the Oven, and be cast in upon the live Coals; and
must be afflicted with these Labours so often repeated, untill they
become fix and ascend no more, but fall down into the Ashes. Which
being washt, will yield a Salt profitable for many things, and will quit
all the costs which have been laid out upon Lead, Salt, and Coals; so
that the Spirit of Salt which is gotten, and that which is amended in
the Lead Oar by the Salt, cost nothing. The Ashes being washt are
to be reduced, in a Furnace, by blast, and be so often tormented, till
a good portion of Silver be gotten by this operation, which the
elaborated matter, being purged by a due separation upon the Tests,
will give. And so shall you have Gold and Silver by the benefit of this
operation, by which [operation] we have manifested unto you the
Great Country Farmer paying his yearly Rent.
Now like as Saturn is dealt withall in this operation, even so are
the other Metals wont to be handled too; but yet you must observe
the Regiment of the fire, which, according to the diversity of the
Metals, must also be diversly administred. And even the Commixtion
it self requires good heeding, as being a business of no small
moment.
Moreover, in this operation you must also note, That one Salt is
more fit for this operation than another is; for by how the sharper
nature they have, so much the more commodious and profitable doe
they shew themselves to be. So Common Salt sublimed, as is done
in this Labour, will operate far stronger than Common Salt it self
unsublimed. Besides, there are Salts to be found which work yet far
more powerfully, yea so strongly, as that they need not the help of
an external fire, but doe produce their effects even in the cold. The
operation of which, in the moist way, if any be desirous to promote
and strengthen by an external fire, he may so doe, in a Lamp-
Furnace, and free himself of the charge of Coals, and be exempt
from that frequent Labour by which the Fire is to be maintained.
Some moist Fires are of such great virtues, as that they need not
any Lamp-fire, but a small golden thread or wire in burning Spirit of
Wine is capable of administring heat sufficient.
And the burning Spirit, if made of Leaves, Grass, rotten Fruit, or
Corn, and Grape-stones or husks will be but of small costs, or in a
manner none at all. Now a pound of such Spirit being placed with a
Golden wiek in a convenient Lamp will suffice for three or four days,
and give heat enough. But yet nevertheless, that moist fire doth
ripen its Metal without the help of any external fire at all, and yields
its profit, but then it requires a longer space of time.
Put case therefore, that I make my moist fire so strong as to be
able to perform its office in the cold, and that it needs not any
external fire: And if I were to make a fire, it would needs require one
Ducket’s charge: If now, standing any-where, it yields me two
Golden Duckets out of the maturated Metal, it wou’d doe well
enough, and abundantly recompence the labour and costs
expended. For there’s nothing wanting of the Metal [you took to
ripen] save that which is changed into Gold and Silver.
And forasmuch as I can set by many such Vessels, and those great
ones too, there’s no doubt to be made, but that my gain will be the
greater, and that with very little labour. For now, at first, the labour
of preparing the moist fire, is in a manner no labour at all, for in
three or four days may be so much made as is sufficient for the
maturating of a great deal of Metal. For this fire may be compared to
a Seed, which being sown in the Earth afore Winter, doth in the
Summer-season produce store of Fruit, and fit to be reaped.
And though this maturation proceeds on exceeding slowly, and
excludes all hast, yet it brings with it this benefit, namely, that it
requireth no other labour in the Winter-time, but to be onely once
laid by, and the perfecting thereof must be committed to God and
Time.
There are various and divers such cold Fires, that promote the
maturation of the Metals, and may be gotten out of divers Subjects,
namely, out of Tartar, Urine, Hairs of Animals, Horns, Calx-vive, Soot,
the Blood of Animals, the Feathers of Birds, the Bones of Horses,
Oxen, and other Beasts, cut of which such a fire is very difficultly
prepared, one of them, here reckoned up, excepted, out of which
the said fire may by an easie labour and business be made, and
without costs. It is therefore a great gift of God, and an especial
grace from our Creator, if he maketh us possessors of such a
Country Farmer, which being sustained without any costs, doth
notwithstanding very largely pay his yearly Rent. To God therefore
are uncessant thanks to be returned for so great a benefit.
But we have said enough of these moist and dry Metal-ripening
Fires; what way soever any one is minded to chuse, that way may
he follow, for it lyes in his own free choice. If he chance to err, let
him not lay the blame upon me, who out of a good mind have
undertaken these labours of writing, but cannot thrust the chewed
meat into any ones mouth. I will by God’s permission show the
wonders of God to some friends this next Summer, that so such as
come after us may likewise have occasion of praising God, and of
giving him thanks.
But even as the common Earth, when it is moistned with often
showers, and now and then freed of them by the heat of the Sun,
retains in it self a fruitfull Salt, and doth necessarily acquire a
fertility: So likewise our Earth doth not onely daily encrease in
goodness, but in weight too, and becomes more ponderous: but you
must not think that this heaviness or weight proceeds from the Spirit
of Salt’s insinuating it self into the porous Earth, no: For if the said
Mass should be but onely eight days time in the digestion, and the
Spirit of Salt be [then] washt off, yet would it be encreased a quarter
part; which ponderosity comes indeed from the Spirit of Salt, out of
which the Saturn draws something unto it self for nutritious sake, as
the Common Earth does out of the showres of Rain, and becomes
more weighty.
For if there were no occult and nitrous virtue in the Rain, it would
conduce but little to fertility; and if there were no spiritual and astral
Gold, or spiritual and astral Sun in Salt, the immature Metals could
not be ripened by the same. By how much the oftner therefore, a
good Spirit of Salt is drawn off from the Saturnine Earth, and
Saturnine Seed, so much the sooner also doth that Seed arrive unto
its full ripeness. For at every turn [of drawing off] something of the
good part of the Spirit of Salt remains behind, attracted by the Earth
and Seed, from which the melioration and augmentation doe arise:
as may be seen in the Vegetable Seeds which sprout forth out of the
Earth, and are encreased by the help of Rain.
The possibility of these things I have seen, but have not hitherto
brought the said matters to a full maturity, or to speak more rightly,
I have not finished the whole operation. He that is minded to make a
thorough trial, may so doe: and if he misseth the effect of his
endeavours, let him not blame me, for I doe not aim at drilling on
any one by my perswasions, to bestow his charges on an uncertain
thing. But I mention these things that so the nature of Metals as also
of Salts may be known, and that (by the help of this knowledge) the
Writings of the Philosophers may be the better understood. For the
labour here proposed avoucheth the truth of those Operations which
the Philosophers call their Calcination, Dealbation, Incineration,
Ascention, Descention, Cohobation, Inceration, Distillation,
Sublimation, Volatilization, Maturation, Fixation, and say that all
these and the like Chymical Operations may be made in one Vessel,
with one Fire, in one Furnace, without any change of the Labours,
Vessels, or Fire.
For the Philosophers have described their greatest secrets and
Arcana’s parabolically, and in Riddles, but especially the Poets, as
Ovid, Virgil, and many others, who are very hard to be understood
by those that have not the knowledge of the nature of Metals, which
being once known and understood, renders the meaning of the
Poets easie. For the Poets were wont to impose one while such a
name upon such a Metal, another time another name upon another
Metal, which custom of theirs, he that does not heedfully mark will
easily fall into an errour, and miss the apprehension of their
meaning.
For Example, in one place they call Copper Venus, in another, the
Wife of Mars, in another, the Sister and Wife of Jupiter. And so deal
they with Silver too, one while they call it Lune, by and by Diana or
Jana, another time Vesta. Apollo is by them stiled one while Sol,
then Phœbus, then Latons, so that it is exceeding necessary, for
those that are desirous to learn ought out of their Writings, to be
well acquainted with those different names and Appellations. And
although the Poets do account all the Metals for the Sons of Saturn,
yet do they sub-distinguish them and stile them, Saturn, Jupiter,
Venus, &c.
The common Lead is Saturn, and so is Antimony, Saturn, Bismute,
Tutia, Lapis Calaminaris, the Ashy Colour, Yellow, White, and red
Magnesia are termed by the name of Saturn: The white Marcasite
and Zink are deemed to be of the Family or Pedegree of Jupiter:
Orichalcum or white and red Copper, are stiled by the name of
Venus. But according as Venus is impregnated, and according as the
Copper is white or red, so hath it its name. The red Copper is as yet
a Virgin. Forasmuch therefore as the Poets have committed unto
Writing the Transmutation of the Metals under the Cover, and vail of
Fables, and have made mention of Saturn, Jupiter, Mars and Venus;
it can never possibly be, that he who knows not this different
distinction can understand their meaning. And for an Example
hereof, consider but the Fable of Diana and Apollo, brought forth at
one Birth by Latona, who was gotten with Child by lying with Jupiter,
and was driven into exile by jealous Juno, and having a long time
suffered Persecution by the biting Serpent Python, and being driven
to flye through all the Countries of the World, did at last after many
grievous labours and troubles pass over the tempestuous Sea into
the Island Ortygia, and betook her self to her Sister Asteria, by
whom she was received, and begat these Twins, viz. Diana and
Apollo.
Who will be able to apprehend the meaning of this Fable, save he
that well understands the nature of the Metals? Verily no body will
so much as dream of or smell out ought of those Mysteries, unless
he shall meet with such like Histories in his metalline labours, and
then at length will he understand what the meaning of the
Philosophers is. But for Example sake, let us take two Metals which
have an affinity with each other, namely Jupiter and Venus, these I
joyn together, that so the Woman may be impregnated with the
masculine Seed. Latona therefore being great with Child, I cast her
forth into exile, that she may be continually persecuted by the biting
Serpent Python, untill she flies through the Salt and stormy Sea, into
the Island Ortygia, to her Sister Asteria, dwelling in the Island
Ortygia, and there bring forth the fair Diana and Apollo. Now these
things are easily understood, were but the genuine Appellations
substituted in the room of such strange terms, of which thing I have
onely some knowledge, but do not profess my self a perfect
Interpreter. Yet methinks I cannot choose but say somewhat. The
venemous Serpent Python is a sirname of Appollo, for he is
produced by the efficacy of the Sun, and is that corrosive Salt which
doth so long afflict and torment the impregnated Latona all over the
dry part of the World, untill she betakes her self by the Sea, that is,
by that strong Salt Water, unto her Sister, that is, unto pure Venus,
and precipitates her self, and brings forth the fruits of Jupiter,
namely, Diana and Apollo together. The Poet doth here mind both
the moist and the dry way together, when the Metal is wrought with
a due Cement, and made fix it is [then] dissolved with the Salt
Water of the Sea, and pure Plates of Venus are put into it thus
dissolved, that so the pure Metal may draw unto it self her
impregnated Sister, who brings together with her Gold and Silver,
which having been so long hidden in its body doth now manifest it
self.
It is indeed the better to fix the Metals by Cements, and so to
render their fugacious Gold and Silver compact, which may be as
well done in the moist way by sharp Waters and moist Fires. But if
the Metals, legitimately impregnated, do first pass through a dry and
burning hot Fire, and are afterwards yet once more transmitted
through the moist and cold Fires, then Pluto sends the mundified
Soul out of Purgatory unto Neptune, by whom it is carried into
Paradise, where it doth afterwards remain safe and free from all
danger of the Serpent.
Upon occasion of the aforesaid Fable, and particular Transmutation
of the inferiour Metals, this is to be yet more observed, that every
Jupiter is not fit to impregnate Latona, but that onely which is yet
living, efficacious, young, and full of Seed is able to impregnate
Latona. For Latona carried with her no more but the Seed onely of
Jupiter into the Island Ortygia, and left behind her all the body of
Jupiter.
Moreover this is to be considered, that Latona did bring forth
Diana first, in the Bosom or Lap of Venus, that is, of the Midwife, but
Diana, presently after she was Born, performed the office of a
Midwife in receiving her Brother Apollo in her Lap, which thing is
sufficiently manifest unto those who have laboured (though but
little) in the Metals. For should the Nativity of Apollo have
preceeded, Venus could not have received him, for which reason
Diana ought to come forth first, that so she might the more
commodiously receive Apollo from Latona. I know not how by any
means it may be proposed more clearly.
Every one that does but know the nature of the Metals doth well
understand, that when Gold and Silver are spiritually dissolved in
one Water, and that plates [of Mars probably] are put in to the
Solution of the Gold and Silver, neither of those Metals will adhere to
the Plates. But if the Plates of Copper are put into that Bath, he shall
presently see that all the Silver that was in the Water will adjoyn it
self thereunto. And now, after that the Silver is thus precipitated and
sticks on to the Copper, the Gold will likewise fall down out of the
Solution, and apply it self to the Silver; which labour I have more at
large handled in the third part of the Prosperity of Germany. It could
not therefore otherwise be, but that Latona must first bring forth
Diana, and Apollo afterwards, seeing that Venus the Sister of Latona
could be helpfull onely in the bringing forth of Diana. It was
therefore necessary that Diana her self should be an assistant in the
Birth of her Brother Apollo, for otherwise he could not have been
Born.
My time admits not of producing any more such similitudes in this
place. We will defer them till some other time, namely, for the
Edition of the Work of Saturn, wherein shall be taught how the most
vile, and most abject Metals are to be maturated by the benefit of
Salts, whereby they may in a particular way yield forth Gold and
Silver.
But forasmuch as I cannot divine, what impediments may put a
stop to the edition of the work of Saturn, and that in this very
Treatise here is often mention made of Saturn. It cannot I think be
any ways hurtfull, if some good thing be yet farther adjoyned. And
such things as are here manifested of Saturn, it will not be needfull
agen to mention them in other places, seeing there doth yet still
remain matter enough for to fill a whole Book of the Secrets of
Saturn. And there lie such wonderfull Secrets under the vile and dirty
Garment of Saturn, as being manifested, would exceed all the belief
of unskilfull Men. For he is not onely an expert Fisher in Fishing
Pearls out of the Salt Sea, but is withall an expert Hunter, in driving
the Wild Beast out of his green Grove or Cops, and of catching him
in his Nets, as we have told you in the foregoing third part of the
Prosperity of Germany.
Nay, he is a bathing Gentleman of singular skill, who by his
bathing and washing his Children, adorneth them with the
comeliness of Diana and Apollo. When he is alone, he serves onely
for Apollo and Diana to wash off their accidental impurities and
defilements, that so they may recover their natural fairness. The
other Metals can’t brook his so over sharp and rigid bathing, but are
rather suffocated and killed therein, than become more fair and
more pure. But if Saturn shall have first washt himself even unto the
highest whiteness, in a Bath of common Salt, he is not then so
austere and severe, but prepares for his Children a far more
tolerable Bath, which being agreeable [or proportionable] to their
Weakness and Sickness, renders them all fairer and more pure. His
greatest virtue consists in his Water which doth both particularly and
universally free the Metals of all their defilements. I have often had a
particular experience [hereof,] and yet daily can (God be praised)
shew and teach the same unto others. But I cannot do any such
thing in an universal way, and inform others as to that; nor do I
vainly brag of so great a matter, though I have my thoughts as
touching the manner how this thing may be effected. Nay the more I
conceived about that matter, the lesser would I boast of the same.
Verily it is a great shame to boast of that thing, of which thou hast
not even the smallest knowledge, or at least dost not know any
thing else, but what thou hast drawn in, by the reading of other
Writers. ’Tis a common proverb, That those Cows which Bellow, or
Low overmuch, are said to yield the least Milk, and that this is a
thing true, yea most true, experience it self doth testifie.
The Chymical Art is become at present so common, that almost
every body, after he hath but viewed over one or two Chymical
Books, (though he never moved his hands to the Work, nor
understands so much as the Chymical Terms themselves) is
nevertheless wont impudently and lyingly to boast of the knowledge
of the universal Medicine. Nay thou shalt see some to proceed on to
that heighth of boldness, as even to write Books of so great a
Secret, and to dare promise the Revelation of the same unto others,
and yet for all this know nothing at all, and have not so much as any
the meanest foundation, but rely solely upon that knowledge, which
(being as we said afore, drawn out of other Writers) causeth in them
a most uncertain hope, of a thing most extreamly obscure.
He that is not a stranger unto, nor ignorant of metallick affairs,
can easily discern the Lyers from the true Writers, and can judge
who are true, and who false. Such as do know somewhat are not
wont to make a bragging noise of their skill. On the contrary, those
Brethren of Ignorance do offer unto every one that most secret
miracle of Art and Nature, namely, the universal Medicine, which
thing a true Philosopher neither ever did, nor ever will do. But as for
the revealing of the particular washings, purgations, and

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Financial Markets and Institutions Tenth Global Edition

The Economics of Money Banking and Financial Markets

Macroeconomics Theory Policy 4th Edition Dwivedi

Advances in Monetary Policy and Macroeconomics Philip

Enterprise Small Business Principles Practice and

Strength Training Anatomy 2nd Edition Frederic Delavier

Macroeconomics 2nd ed Edition Rafferty

Macroeconomics 2nd Edition Manfred Gartner

Chapter 2 Measuring • Can GDP Buy Happiness? • Unemployment and Employment

Chapter 3 Aggregate • Why Are Some Countries Rich and

Chapter 5 Appendix The • Quantitative Easing and the Money

Chapter 6 The Sources • Evidence on Convergence, • China’s One-Child Policy

Chapter 7 Drivers of • Does Population Growth Improve • Government Measures to

Chapter 8 Business • Leading Economic Indicators

Chapter 10 Monetary • Movements Along the MP

Chapter 12 The ation, 1980–1986

Chapter 13 ation • The Federal Reserve’s Use of the

Chapter 14 The Financial • The Tyranny of Collateral

Chapter 16 Fiscal Policy • The Entitlements Debate: Social

Cataloging-in-Publication Data is on file at the Library of Congress

ISBN 10: 0-13-342431-6

PART 2 Macroeconomic Basics . . . . . . . . . . . . . . . . . . . . . . . . 48

PART 3 Long-Run Economic Growth . . . . . . . . . . . . . . . . . . . 144

PART 4 Business Cycles: The Short Run . . . . . . . . . . . . . . . . 204

PART 5 Finance and the Macroeconomy . . . . . . . . . . . . . . . . 370

PART 6 Macroeconomic Policy . . . . . . . . . . . . . . . . . . . . . . . 425

PART 7 Microeconomic Foundations of Macroeconomics . . . . . 492

PART 8 Modern Business Cycle Analysis

Measuring GDP: The Income Approach . . . . . . . . . . . . . . . . 28

PART 2 Macroeconomic Basics . . . . . . . . . . . . . . . . . 48

Chapter 4 Web Appendix

Chapter 5 Web Appendix

PART 3 Long-Run Economic Growth . . . . . . . . . . . . 144

Application: Evidence on Convergence, 1960–2012 . . . . . . . . . . . . 154

Chapter 6 Web Appendix

POLICY AND PRACTICE: Government Measures to

PART 4 Business Cycles: The Short Run . . . . . . . . . . 204

Time Horizons in Macroeconomics . . . . . . . . . . . . . . . . . 221

Changes in Equilibrium: Aggregate Supply

Chapter 12 Web Appendix A

Chapter 12 Web Appendix B

Chapter 12 Web Appendix C

The Bottom Line: The Relationship Between Stabilizing

PART 5 Finance and the Macroeconomy . . . . . . . . . 370

APPLICATION: The Tyranny of Collateral . . . . . . . . . . . . . . . . . . . . . . 380

Chapter 14 Web Appendix

Ireland and the 2007–2009 Financial Crisis . . . . . . . . . . . . . . . . . . . 406

PART 6 Macroeconomic Policy . . . . . . . . . . . . . . . . 425

Fiscal Multipliers at the Zero Lower Bound . . . . . . . . . . . . . . . . . . . . . 443

Chapter 16 Web Appendix

APPLICATION: Why Are Exchange Rates So Volatile? . . . . . . . . . . . . . 473

Chapter 17 Web Appendix A

Chapter 17 Web Appendix B

PART 7 Microeconomic Foundations of

The Intertemporal Choice Model in Practice:

Chapter 18 Web Appendix

PART 8 Modern Business Cycle Analysis

PART 7 Microeconomic Foundations of

PART 8 Modern Business Cycle Analysis and

e conomic phenomenon that takes a mathematical or graphical form. The development