AbouttheAuthor
JohnE.Marthinsen isProfessorofEconomicsandInternationalBusinessatBabsonCollegein BabsonPark,MA,whereheholdsTheDistinguishedChairinSwissEconomics.Hisprimary researchinterestsareintheareasofinternationalmacroeconomics,corporatefinance,and internationalfinancialmarkets.Anaward-winningteacher,heisalsotheauthorofmany articlesandbooks.Amonghisrelatedbooksare RiskTakers:UsesandAbusesofFinancial Derivatives,ThirdEdition(WalterdeGruyter,Inc.,2018), InternationalMacroeconomicsfor BusinessandPoliticalLeaders (Routledge,2017), SwissFinance:CapitalMarkets,Banking, andtheSwissValueChain (JohnWiley&Sons,2013) co-authoredwithHenriB.Meierand PascalB.Gantenbein, WealthbyAssociation:GlobalProsperitythroughMarketUnification (GreenwoodPublishingGroup/QuorumBooks,2003) coauthoredwithJohnC.Edmunds,and Switzerland:AGuidetotheCapitalandMoneyMarkets (London,England:EuromoneyBooks, 1996) coauthoredwithDr.HenriB.Meier.
JohnMarthinsenreceivedhisB.A.in1970fromLycomingCollege.BothhisM.A.(1972) andPh.D.(1974)degreeswereearnedattheUniversityofConnecticut.Hehasextensive consultingexperience,workingforbothdomesticandinternationalcompaniesandbanks,as wellasfortheU.S.government.Dr.MarthinsenhaslecturedattheUniversitiesofBernand BaselinSwitzerlandandtheUniversityofNuremberginGermany.From1992to1998,he servedasChairmanofBabsonCollege’sEconomicsDivision,andfrom2000to2009,hewas amemberoftheBoardofDirectorsforGivaudanSA,aSwiss-basedflavorsandfragrances company.
https://doi.org/10.1515/9781547401437-203
Preface
DemystifyingGlobalMacroeconomics (DGM)bridgesthegapbetweenthetheoreticalandpracticaluseandunderstandingofinternationalmacroeconomics. Forseriousbusinessandpoliticalleaders,understandingtheglobalinterconnectionsineconomicandfinancialmarketsiscrucialformakinginformedand well-timeddecisions. DGM takesthemysteryoutofseeminglycomplexeconomicinteractionsbyprovidingalogicalframeworkwithinwhichtoanalyze theeffectsofeconomic,social,andpoliticalshockstoanation’seconomy.
Thecontentsofthisbookaresophisticatedbutnot “rocketscience.” IfI wroteitcorrectly,eachsectionshouldfollowinalogicalordertobuildanunderstandingofhowtheglobaleconomyworks.Myapproachistorelyoncommonsense,withthebeliefthatonlyifaconceptappealstoyoursensibilities andintuitionwillitberememberedandusedasavaluabledecision-making tool.Withthehelpofsupplyanddemandanalysis,thisbookexplainshowprices,rates,andquantitiesperperiodaredeterminedintherealcreditmarkets, realgoodsandservicesmarkets,andforeignexchangemarkets.Itthengoeson toshowhowthesethreemajormacroeconomicmarketsareinterconnected.
Theprinciplesinthisbookhavearichhistory,whichhasevolvedover time.Whilethereisstillcontroversyineconomiccircles,itisfairtosaythat thereismuchmoreagreementthandiscord.Understandingglobalmacroeconomicsbringsstructureandorganizationtocommercial,financial,political, andsocialdecisions.Itslogicandcircuitryareusefulforanalyzingcurrent, past,andpossiblefutureeconomicevents,andthisusefulnessisnottiedto anygeographiclocation.
Acommondenominatoramongalltheimportantmacroeconomicvariables isthattheyaredeterminedbymarketforcesandnotbymanagers.Nevertheless, goodbusinessmanagersunderstandhowtoanticipate,reactto,andcopewith theshiftingtidesofeconomicfortuneandmisfortune,justasgoodsailorstryto anticipate,reactto,andcopewithchangingweatherconditionsoverwhichthey havenocontrol.
Possessingasolidmacroeconomicframeworkempowersmanagerswith theabilityto:
– Create,criticallyevaluate,andeffectivelyusecountryanalysestoimprove financialstatementprojections(e.g.,incomestatements,balancesheets, andcashflowstatements)
– Integrateanticipatedeconomicchangesandgovernmentpoliciesintobusinessstrategiesthatincreasecompetitivenessandperformance
– Formulatereasonedopinionsaboutthecausesofandcuresforchronic economicillnessesincountries
https://doi.org/10.1515/9781547401437-204
Understandtheeconomicimpactandsustainabilityofproposedpolitical legislation
Economiccausesandeffectshaveshort-termandlong-termimplications.This bookviewstheshort-termasaperiodfromone-to-fiveyears,whichisconsistent withcompanies’ budgetandbusinessplantimehorizons.Itisalsogenerallyconsistentwiththetermsofofficeformanycountries’ presidentsandprimeministers.Thelong-termisfor10-to-20-yearscenario-planninganalyses.Theluxuryof timeoffersgreaterdegreesofbusinessflexibilityandmaneuverabilitythanthe shortterm.
Bytyingtogetherrelevanteconomicprinciples,thisbookexplainshowto answerquestions,suchas:
– WhateffectsshouldU.S.tariffsonChineseimportshaveoneconomicconditions(e.g.,grossdomesticproduct,unemploymentrate,inflationrate,interestrates,andexchangerates)intheUnitedStatesandChina?
– Presidentialcandidatesoftenpromisetopasslargeinfrastructurespending billstorepairandmodernizeagingroads,bridges,andairports.How shouldinfrastructurespending,andthefinancingneededtosupportit,affectanation’seconomicconditions?
– SupposeinvestmentrisksinArgentina,forinstance,increaserelativetothe UnitedStates,causingmassivesalesofArgentinepesosforU.S.dollars. WhateffectshouldcapitalflighthaveonArgentina’seconomicconditions?
– InNovember2016,Indialaunchedanambitiousdemonetizationprogram withanumberofgoalsinmind.OneofthemwastohaveIndia’sresidents embracecashlessexchangeinmuchgreaternumbers.Whateffectshould anincreaseinelectronicpaymentshaveonIndia’seconomy?
– SupposetheU.S.governmentfindsawaytosubstantiallyreducethedrug abuseproblem,ingeneral,andthedrugoverdoseproblem,inparticular, causinganincreaseinthenation’semployment-to-populationratio.What effectshouldthissuccessfulefforthaveonU.S.economicconditions?
– Carbontaxproponentsclaimthatthislevywouldbemoreeffectiveatcurbingpollutionandfightingclimate-changethangovernmentregulations. Whateffectshouldacarbontaxhaveontheadoptingnation’seconomic conditions,governmentbudget,andmoneysupply?
– Aborder-adjustmenttaxwouldprohibitcompaniesfromdeductingthe costsofimportedinputsfromgrossrevenues,whentheyreporttheirtaxableearnings.Atthesametime,itwouldremovecorporatetaxesonexport revenues.Thiscombinationisequivalenttoataxonimportsandasubsidy forexports.Whateffectsshouldabordertaxhaveonthenation’seconomic conditions?
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XII Preface
In2018,SaudiArabiaimposeditsfirst-evervalue-addedtax(VAT)of fivepercentontheconsumptionofmostgoodsandservices.Whateffects shouldaVAThaveonSaudiArabia’seconomicconditions?
Boliviareliesheavilyonexportedcommodities.Whateffectsshouldfalling worldcommodityprices(e.g.,thepricesofmineralfuels,ores,andpreciousmetals)haveonBolivia’seconomy.
Overviewofthetext
DemystifyingGlobalMacroeconomics isdividedintosixparts.Parts1–5build anintegratedmacroeconomicframeworkcalledthe Three-SectorModel, which willbeusedtoexplainhoweconomic,political,andsocialshockscancause multipleandinterrelated short-term economicchanges.Ateachstepofthe way,youwillbeurgedtoaskyourselfwhetherornottheeconomicconcepts introducedandreasoningusedmeet your testsofcommonsense.Part6deals with long-term economicrelationships.Let’slookabitdeeperatthesesixparts togainabetterunderstandingofthetopicstheycover.
Part1(Chapters1to5)
Part1focusesonhowtomeasureanation’seconomichealthandmonitoritfor changes.Centraltothisdiscussionisunderstandinganation’slabormarket conditionsandthedifferencebetweenreal(i.e.,inflation-adjusted)andnominalmacroeconomicvariables,suchasgrossdomesticproduct(GDP),interest rates,andwages.Onereasoninflationisacentralfocusofanybookonmacroeconomicsisbecauseunexpectedchangesininflationcreateeconomicbeneficiariesandvictims.Whoarethevictimsandbeneficiaries?Doesinflationhurta nation’soverallstandardoflivingormerelyredistributeincomeandwealth amongcompetinggroupswithinthenation?Part1addressestheseissues.
Part2(Chapters6to11)
Part2focusesonfinancialmarkets.Itbeginsbydefiningthemostimportant monetaryaggregatesandthendiscussesthefunctionsofmoney,aswellasthe importantroleoffinancialintermediariesandhowtheycancreatemoney.The abilitytocreatemoneyisapowerfulone,soPart2explainscentralbanks’ monetarycontrols.Withanunderstandingofthemonetaryaggregatesandhow
–
–
Preface XIII
theychange,aswellashowcentralbanksregulatedomesticliquiditylevels, Part2thenfocusesontherealcreditmarket,wherethecostofrealcredit(also calledtherealinterestrate)andquantityofrealcreditperperiodaredeterminedbytheforcesofsupplyanddemand.Part2endswithadiscussionof cryptocurrencies,whethertheyare “money,” theireconomicbenefits,andthe concernsthatgovernmentsandcentralbankshaveabouttheeffecttheymight haveonnations’ taxbases,monetarypolicies,andcriminalactivities.
Part3(Chapters12to14)
Part3coverstherealgoodsandservicesmarket,usingaggregatesupplyand aggregatedemandanalysistoexplainwhatcausesanation’srealGDPand GDPPriceIndextochange.Theeffectsoffiscalpolicies(i.e.,government spendingandtaxation),automaticstabilizers,andbusinesscycles(i.e.,periodiceconomicexpansionsandcontractions)arealsoexplainedinPart3.
Part4(Chapters15to17)
Globalmacroeconomictopicsareinfu sedintothisbookfromthebeginning, butPart4divesmoredeeplyintotheinternationalsector.Webeginbydiscussingtheforeignexchangemarket ’sstructure,keymarketparticipants,and theeffectsthatforeignexchangetransactionshaveonnations’ moneysupplies.Careistakentoexplainhowtoreadandunderstandcurrencyquotationsandtodistinguishbetweenbilateralandeffectiveexchangerates,as wellasnominalandrealexchangerates.Part4goesontoaddresshowthe forcesofsupplyanddemanddetermineexchangeratesandhowchangesin exchangeratesaffectcountries ’ internationalcompetitiveness.Finally,Part4 endsbyfocusingonhowtoreadandinterpretcountries ’ balanceofpayments reports.ItusestheInternationalMonetaryFund ’ s(IMF)approachtoreporting balanceofpaymentsfigures(ratherthanusinganyparticularnation ’ sapproach)becauseIMFdatacanbeusedforcross-countrycomparisons.This chapterexplainsthemostimportantbalanceofpaymentsmeasures,what theyrevealaboutanation ’seconomicconditions,andthewaysinwhich managerscanusethemtomakewell-i nformeddecisionsconcerningeach worldmarketinwhichtheyparticipate.
XIV Preface
Part5(Chapters18to21)
Part5synthesizestheinformationfromParts1to4intothe Three-SectorModel. Atthispoint,youwillunderstand:(1)howtherealinterestrateandthequantityofrealcreditperperiodaredeterminedintherealcreditmarket,(2)how theGDPPriceIndexandrealGDParedeterminedintherealgoodsandservices market,and(3)howthenominalexchangerateandthequantityofforeignexchangeperperiodaredeterminedintheforeignexchangemarket.Thegoalof Part5istointegratethesethreemarketsandshowhowchangesinoneofthem causepredictablechangesintheothertwo.
Thebeautyofthe Three-SectorModelisthatitempowersyoutoconductan economicanalysisofanycountry,understandthoseofothers,criticallyevaluate articlesandeditorialsinthebusinessmedia,suchas TheWallStreetJournal, FinancialTimes,andTheEconomist,tobetterformulatefinancialstatementprojectionsandcontributemeaningfullytobusinessstrategyandplanningdiscussions.Part5analyzestheshort-termeffectsofshockstocountrieswithflexible and fixedexchangerates.ProminentinPart5istheroleofinternationalcapital mobility1 andhowitsvariationscanaffecteconomicoutcomes.Part5endswitha casestudyoftheGreatRecession,whichlastedfromDecember2007toJune2009 andwillberememberedbymanyasalowpointinU.S.economicperformance andfinancialregulation.
Part6(Chapters22and23)
Part6opensourmacroeconomicanalysestolong-termbusinessplanningissues, whichareparticularlyimportanttocompaniesthatareconsideringstrategicmaneuvers,suchasmergers,acquisitions,anddivestitures,aswellaschangesin sourcing,production,ormarketing.Thispartbeginsbydiscussingscenarioplanningandthemajorcausesoflong-termdevelopment.Then,itexplainscomparativeadvantage,whichdemonstrateshowopentradecanbeawin-winproposition. Part6goesontoexplainwhytheeconomicreasoningbehindgoodmacro-level decisionsatthenationalgovernmentlevelmaybequitedifferentfromgoodcompany-leveldecisions.Forinstance,anation’sGDP isnotlike acompany’sgross salesrevenues;mostcountrieshavetheirowncurrencies,butcompaniesdonot;a majorityofcountriesconsumeinternallymostofwhattheyproduceandsource
1 Ingeneral,internationalcapitalmobilityistheresponsivenessofglobalinvestmentflowsto relativeinternationalinterestratechanges. Preface XV
fromthemselvesthevastbulkoftheirneededinputs,butcompaniesdonot.
Countrieshavefull-employmenttargetsandusemonetaryandfiscalpoliciesto reachthesegoals,whilenothingcomparableexistsatthecompanylevel.Forthese reasons,thebesttreasuryofficials,centralbankers,andtop-notchpublicpolicymakersmaynotbethemostsuccessfulchief executiveofficersandchieffinancial officers.Part6thendiscussesmonetarism,thequantitytheoryofmoney,causesof long-terminflation,andthelong-runPhillipsCurve,whichaddresseswhethernationsfacealong-termtrade-offbetweenunemploymentandinflation.Thenaturalratehypothesisisusedinthissectiontofacilitatethediscussion.
What’snewinthethirdedition?
Thethirdeditionhasalreadybeentestedonabout150MBAstudentsat BabsonCollege,towhomIoweanenormousdebtofgratitudefortheir thoughtfulfeedbackandsuggestions.BabsonCollege ’ sstudentpopulationis highlyinternational,whichmakesteachingthismaterialapleasurebecause itislikepresentingglobalmacr oeconomicstoaUnitedNations’ audience. KnowingthatEnglish,formanyofmystudents,istheirsecond(orthird, fourth,ormore)language,Ihavereducedthelengthofthisbookandtriedto keepitfreeofeconomicjargon.Whatj argonremainsslippedpastmybesteffortsandispurelyunintentional.
Inkeepingwiththesecondedition,Ihaveseparatedeachchapterinto “TheBasics” and “TheRestoftheStory.”“TheBasics” sectioncontainsmaterialthatisessentialtobuildasolidfoundationinglobalmacroeconomics. “The RestoftheStory” materialprovidesstudents,professors,andotherinterested readerswithflexibilitytopickandchoosetopicsofinterestthatsupporttheir timeconstraintsandinterests.
Thechaptersequenceandsomeofthetitles,inthethirdedition,areslightly differentfromthesecondedition.TableP.1highlightsthesimilaritiesanddifferences.Twonoticeablechanges,whichwillbediscussedbeloware:(1)thematerialonbusinesscycleshasbeenmovedfromChapter4, “Inflation,RealGDP,and BusinessCycles” (secondedition)toChapter14, “BusinessCycles” (thirdedition), and(2)thematerialinChapter10, “TheEconomicsofVirtualCurrencies” (second edition)hasbeenalmostcompletelyrewrittenandplacedintoChapter11, “The EconomicsofCryptocurrencies” (thirdedition).
Chapter2, “TakinganEconomicPulseBeat” hasbeenreorganizedinthe thirdeditionbyfocusing “TheBasics” ongrossdomesticproduct(GDP)and leavingnuancesrelatedtodifferencesbetweenGDPandgrossnationalproduct (GNP)for “TheRestoftheStory” sectionofthechapter.
XVI Preface
TableP.1: TableofContentsComparisonforDGM’sSecondandThirdEditions.
ChapterThirdEditionChapterTitleChapterSecondEditionChapterTitle
FMPreface
Introduction
TakinganEconomicPulse
LaborMarketConditions
InflationandRealGDP
Inflation:WhoWins,andWho Loses?
MonetaryAggregates
FinancialIntermediation
MoneyCreation
FMPreface
IntroductiontoInternational Macroeconomics
TakinganEconomicPulse:Measuring NationalOutputandIncome
UnderstandingandMonitoringLabor MarketConditions
Inflation,RealGDP,andBusiness Cycles
Inflation:WhoWins,andWhoLoses?
MonetaryAggregates:Measuring Money
FinancialIntermediation,Markets,and Intermediaries
ThePowerofFinancialInstitutionsto CreateMoney CentralBanks
WhoControlstheMoneySupplyand How?
RealCreditMarkets
TheEconomicsof Cryptocurrencies
RealGoodsandServicesMarkets
FiscalPolicy
BusinessCycles
ForeignExchangeBasics
ForeignExchangeMarkets
BalanceofPayments
PuttingItAllTogether
TheEconomicsofVirtualCurrencies
InterestRatesandWhyTheyChange
PriceandOutputFluctuations
FiscalPolicyandAutomaticStabilizers: WhatManagersNeedtoKnow
BasicsofForeignExchangeMarkets
ExchangeRates:WhyDoTheyChange?
BalanceofPaymentsFundamentals
PuttingItAllTogether
EconomicShockstoNationswith FlexibleExchangeRates
Preface XVII
TableP.1 (continued)
ChapterThirdEditionChapterTitleChapterSecondEditionChapterTitle
ShockstoNationswithFlexible ExchangeRates
EconomicShockstoNationswith FixedExchangeRates
Causes,Cures,and ConsequencesoftheGreat Recession
Long-TermGrowthand Development
Long-TermInflation,Exchange RatesandUnemployment
EconomicShockstoNationswithFixed ExchangeRates
Causes,Cures,andConsequencesof theGreatRecession
CausesofLong-TermGrowthand Development
Long-TermExchangeRateMovements andComparativeAdvantage
EMIndex EMIndex
EMAbbreviations
EMImportantMacroeconomic Relationships
EMAbbreviations
EMImportantMacroeconomic Relationships
ThesectioninChapter3, “LaborMarketConditions” (thirdedition)entitled “Outsourcing,Offshoring,andReshoring,” startsbydistinguishingamongoutsourcing,offshoring,andreshoringandthengoesontoexplainthelikelylongtermmacroeconomiceffectsofoffshoring.Inthethirdedition,Itrytodoabetterjobexplainingthesignificantshort-termtransitionalcostsassociatedwith offshoringand,therefore,theethicalchoicesnationsmayface.Thischapterremindsusthateconomicsprovidesanswersthatshouldbenuancedandput intoabroaderperspective.
Chapter4, “InflationandRealGDP” (thirdedition)differsfromthesecond editionbyeliminatingthediscussionofbusinesscycles.Instead,thismaterial hasbeenmovedtoChapter14, “BusinessCycles” (thirdedition).Asaresult, thebusinesscyclediscussionisnowmuchclosertoChapter12, “RealGoods andServicesMarket” (thirdedition),wherethecausesofrealGDPmovements arediscussed.AlsomovedfromChapter4, “Inflation,RealGDP,andBusiness Cycles” (secondedition)isthediscussionofhyperinflationanddeflation, whichcannowbefoundinChapter12, “RealGoodsandServicesMarkets.” Chapters6to10(thirdedition)focusonU.S.andglobalfinancialmarkets. Chapter6, “MonetaryAggregates ” andChapter8, “ MoneyCreation” (third edition)aresimilartotheircounterpartsinthesecondedition.Chapter7,
XVIII Preface
“FinancialIntermediation, ” hasbeensupplementedbyasectionentitled FinancialDisintermediation,DistributedLedgers,Blockchain,andSmart Contracts. Thismaterialissuretopiquetheinterestsofthosecuriousabout cryptocurrenciesandtheireffectsonnations ’ financialsystems.
InChapter9, “CentralBanks” (thirdedition),Ihaveaddedashortdiscussionofmicroprudentialandmacroprudentialregulations.In “TheRestofthe Story” portionofthischapter,Ihavealsoincludedabriefdiscussionofvarious monetarypolicytargets,suchasinflationrates,interestrates,moneysupply growthrates,GDPgrowthrates,andexchangerates.Removedfromthethird editionarethesecondedition’sappendices,entitled “WhoRegulates U.S.Banks, ”“StructureoftheFederalReserveSystem, ”“WhoControlsthe Fed? ”“ABriefHistoryoftheFederalReserveSystem,” and “U.S.DollarFacts andFigures.”
Inthethirdedition,substantialchanges(mainlyinterminology)havebeen madetothediscussionofhowinterestratesaredetermined.Chapter10, “Real CreditMarkets” (thirdedition)replacesChapter11, “InterestRatesandWhy TheyChange” (secondedition).Itfocusesontherealcreditmarketandcostof realcredit(alsocalledtherealinterestrate).Thesecondeditionfocusedonthe realloanablefundsmarket and realrisk-freeinterestrate.Thethirdedition bringsthematerialinthischapteranditsterminologyintocloseralignment withwhatweallreadinnewspapersandthefinancialnews.Ialsoaddedto Chapter10ashortdiscussionofthe liquiditytrap,whichhasbecomeatopicof discussionsincetheGreatRecession(2007–2009).RemovedfromChapter10 (thirdedition)isthesecondedition’scoverageof “PerfectlyMobileand PerfectlyImmobileInternationalCapitalMarkets.”
Chapter11, “TheEconomicsofCryptocurrencies” (thirdedition)hasbeen almostcompletelyrewrittenbecausesomuchhaschangedsincepublicationof thesecondedition(i.e.,Chapter10, “TheEconomicsofVirtualCurrencies”). Forinstructorswhocanallocateabitofextratime,thischapterpromisesto raiseinterestingquestionsforeveryoneinclass.Ifthecryptocurrencymarkets growtosignificantsize,dotheyhavethepowertothwartcentralbanks’ abilitiestocontroltheirnations’ (orcurrencyareas’)moneysuppliesandinflation rates?Dotheyunderminegovernments’ taxbasesandenableillegalfinancial activities,suchastaxevasionandmoneylaundering?
Inthethirdedition,Chapters12to14focusontherealgoodsandservices market.Chapter12, “RealGoodsandServicesMarkets” (thirdedition)replaces Chapter12, “PriceandOutputFluctuations” (secondedition).Similarly, Chapter13, “FiscalPolicy” (thirdedition)replacesChapter13, “FiscalPolicy andAutomaticStabilizers:WhatManagersNeedtoKnow” (secondedition). ThecontentofChapters12and13hasbeenupdatedbut,otherwise,itisvery
Preface XIX
similartothesecondedition.WhilethecontentofChapter13(thirdedition)is similartothesecondedition,theorderinwhichthematerialispresentedhas changed.First,Imovedthesectionentitled “ActiveversusPassiveDeficitsand Surpluses” from “TheBasics” to “TheRestoftheStory” andchangedtheterminologyabit.Insteadofdiscussing “active” and “passive” deficits,Iusethe terms “structural” and “cyclical” deficits,whichweseemoreofteninthenew mediaandacademicliterature.
Inthethirdedition,Chapter14, “BusinessCycles” isnowanewandseparatechapter,butmostofthematerialcoveredinthischapterwasformerlyin Chapter4, “Inflation,RealGDP,andBusinessCycles” (secondedition).
Inthethirdedition,Chapters15to17focusonforeignexchangemarkets andthebalanceofpayments.Chapter15, “ForeignExchangeBasics” (thirdedition)replacesChapter14, “BasicsofForeignExchangeMarkets” (secondedition).RemovedfromChapter15(thirdedition)istheextendeddiscussionof forwardexchangemarkets,whichwasincludedinthesecondedition.
Chapter16, “ForeignExchangeMarkets” (thirdedition)issimilarto itssecondeditioncounterpart,Chapter15,entitled “ExchangeRates:WhyDo TheyChange?”),buttheappendixentitled “CantheSupplyofForeignExchange SlopeDownward?” hasbeenremoved.
Chapter17, “BalanceofPayments” (thirdedition)hasbeensubstantiallyrevised andforgoodreason.Ihavetriedtomakethisbookascurrent,readable, anduseableaspossible.Tothisend,IhavechosentofocusontheIMF’spresentationofnations’ balanceofpaymentsstatistics.In2013,theIMFtriedto makeitsbalanceofpaymentsstatisticsmoretransparentanduser-friendlyby usingrulesandguidelineslaidoutinitsreportentitled BalanceofPayments andInternationalInvestmentPositionManual:SixthEdition (BPM6).2 Thisnew approachtomeasuringinternationaltransactionsreplacedtheoldversion (BPM5),3 whichwasreleasedin1993.
Chapters18to20(thirdedition),puttogethereverythingyouhavelearned fromthebeginningofthebook.Theterminologyinthesechapters,especially withrespecttotherealcreditmarketandbalanceofpayments,hasbeenupdated.Inthethirdeditionof DGM,importantdistinctionsaremadebetween shocksthathave direct and indirect impactsontheeconomyandalsobetween primary and secondary economiceffects.
2 IMF, BalanceofPaymentsandInternationalInvestmentPositionManual:SixthEdition (BPM6),2013,https://www.imf.org/external/pubs/ft/bop/2007/bopman6.htm.
3 IMF, BalanceofPaymentsManual ,1993,https://www.imf.org/external/np/sta/bop/ BOPman.pdf.
XX Preface
Chapter19, “ShockstoNationswithFlexibleExchangeRates” and Chapter20, “ShockstoNationswithFixedExchangeRates” (thirdedition)are similartothesecondedition.Toshortenthecontents,Ihaveremovedfrom Chapter20thesectionentitled “RiseandFalloftheAsianTigers:1985–1997.” Thenewend-of-chapterreviewanddiscussionquestionsshouldhelpcompensateforthislossofmaterial.
Chapter21, “Causes,Cures,andConsequencesoftheGreatRecession” (thirdedition)hasbeenupdatedandcarriesthesamenameasChapter20in thesecondedition.Thenewversiondiscusseswhathashappenedsincethe GreatRecessionended.
Chapter22, “Long-TermGrowthandDevelopment” (thirdedition)and Chapter23, “Long-TermInflation,ExchangeRates,andUnemployment” (third edition)aresimilartoChapter21, “CausesofLong-TermGrowthandInflation” (secondedition)andChapter22, “Long-TermExchangeRateMovementsand ComparativeAdvantage” (secondedition),butthecontenthasbeenreorganizedtomatchthenewchaptertitles.RemovedfromChapter21(secondedition) andplacedintoChapter23(thirdedition)arediscussionsoftheequationofexchange,monetarism,quantitytheoryofmoney,naturalrateofunemployment, andPhillipsCurve.RemovedfromChapter22(secondedition)andplacedinto Chapter22(thirdedition)arediscussionsofcomparativeadvantageandwhya countryisnotacompany.
Preface XXI
AcknowledgmentsVII
AbouttheAuthorIX
PrefaceXI
Chapter1
IntroductiontoGlobalMacroeconomics1
TheBasics 1
ThreeMajorMacroeconomicMarkets 3
BusinessUsesofMacroeconomicAnalyses 5
MacroeconomicAnalysisforEconomistsandPolicymakers 7
Let’sBegin! 8
TheRestoftheStory 8
FourMajorBusinessPlanningDocuments 8
Conclusion 10
KeyPoints 11
ReviewQuestions 11
DiscussionQuestions 12
Chapter2
TakinganEconomicPulse13
TheBasics 13
NominalGrossDomesticProduct 13
ShortcomingsofGDPasaMeasureofEconomicHealth 16
CircularFlowDiagram 17
MacroeconomicEquilibrium 25
TheRestoftheStory 27
ASecondWaytoViewMacroeconomicEquilibrium 27
UsingtheCircularFlowtoExplainRecessions 29
HowDoGovernmentsActuallyCalculateGDPandGDI? 31
GrossNationalProduct 34
UndergroundEconomies 36
Conclusion 38
KeyPoints 38
ReviewQuestions 39
DiscussionQuestions 41
Contents
Chapter3
LaborMarketConditions43
TheBasics 44
WhoUsesLaborMarketInformation? 44
MeasuringEmploymentandUnemployment 46
FourTypesofUnemployment 51
StrengthsandWeaknessesofLaborMarketMeasures 55
FinalCommentsonInterpretingUnemploymentRateand Employment-to-PopulationRatio 59
TheRestoftheStory 60
OtherLaborMarketMeasures 60
IfOnlyICouldBeaFlyontheWall 63
NaturalRateofUnemployment 65
Outsourcing,Offshoring,andReshoring 66
Conclusion 71
KeyPoints 72 ReviewQuestions 74 DiscussionQuestions 74
Chapter4
InflationandRealGDP77
TheBasics 77
77
79
82 RealVersusNominalGDP 83
TheRestoftheStory 85 WeaknessesoftheCPI 85 Conclusion 88
KeyPoints 89 ReviewQuestions 90 DiscussionQuestion 90
Chapter5
Inflation:WhoWins,andWhoLoses?91
TheBasics 91
InflationDiminishesPurchasingPower 91 FramingtheInflationIssue 92
WhatIsPriceStability?
WhatIsInflation?
InflationMeasures
XXIV Contents
DebtorsVersusCreditors 94
BusinessesVersusWorkers 99
GovernmentsVersusTaxpayers 100
DoesInflationHurtRetirees? 101
DoesInflationHurttheNationasaWhole? 102
TheRestoftheStory 104
Indexation 104
HowtoProfitfromaNegativeRealInterestRate 106
CalculatingNominalInterestRateswiththePreciseFormula 107
EstimatingMarketExpectationsaboutFutureInflation 108
InflationandtheCostofHigherEducation 110
Conclusion 111
KeyTerms 111
ReviewQuestions 112
DiscussionQuestions 113
Chapter6 MonetaryAggregates115
TheBasics 115
CommodityMoneyVersusFiatMoney 115 FunctionsofMoney 117
WhyDoNationsMeasureTheirMoneySupplies? 118 MonetaryAggregates 120
TheRestoftheStory 126
U.S.MonetaryAggregates 126
FinancialAssetsIncludedintheU.S.M1andM2MoneySupplies 128 Conclusion 131 KeyPoints 131 ReviewQuestions 132 DiscussionQuestions 133
Chapter7 FinancialIntermediation135
TheBasics 135 FinancialIntermediaries 135 OverviewofaTypicalBank’sBalanceSheet 139 CheckClearing 146
TheRestoftheStory 149 FinancialDisintermediation 149 InternationalCheckClearing 152
Contents XXV
CheckClearingandCompanyCashManagement 153
CausesofBankFailures 155
Conclusion 157
KeyPoints 158
ReviewQuestions 159
DiscussionQuestions 160
Chapter8
MoneyCreation161
TheBasics 161
CreationofMoneybyaSingleBank 161
MoneyCreationbytheBankingSystem 171
TheRestoftheStory 178
PreferredAssetRatiosandtheM1andM2MoneyMultipliers 178
Conclusion 187
KeyPoints 187
ReviewQuestions 188
DiscussionQuestions 191
Chapter9
CentralBanks193
TheBasics 193
FinancialRegulationVersusMonetaryPolicy 193
M2 ≡ M2MoneyMultiplier×MonetaryBase 194
Guideline#1:AbovetheLine/BelowtheLine 195
MonetaryToolsoftheCentralBank 199
MonetaryToolsinAction 213
LagsinMonetaryPolicy 214
Summaryof “TheBasics” 215
TheRestoftheStory 216
CentralBanking:ABalanceSheetView 216
CanaCentralBankBecomeInsolvent? 222
MacroprudentialRegulations 223
MonetaryPolicyTargets 224
MonetaryEffectsofCentralBankForeignExchangeMarket
Intervention 230
CentralBanksAroundtheWorld 234
Conclusion 237
KeyPoints 238
XXVI Contents
ReviewQuestions 240
DiscussionQuestions 241
Chapter10
RealCreditMarkets243
TheBasics 243
ClarifyingFinancialMarkets 243
InverseRelationshipBetweenDebtPricesandInterestYield 245
CostofRealCredit 245
DeterminingCredit’sRealCostandQuantityPerPeriod 251
ShiftsintheSupplyandDemandforRealCredit 257
RealCreditMarketExamples 266
TheRestoftheStory 273
CanCentralBanksSetInterestRates? 273
Conclusion 275
KeyPoints 276
ReviewQuestions 278
DiscussionQuestions 279
Chapter11
TheEconomicsofCryptocurrencies281
TheBasics 281
LegalTender,Fiat,Digital,andCryptocurrencies 281
Buying,Selling,andUsingCryptocurrencies 283
Blockchain,Altcoins,andEnterpriseDistributedLedger Technology 286
CryptocurrencyExchangeRateDetermination 288
CryptocurrenciesandMonetaryPolicies 291
TaxationandGovernmentRegulation 293
AreCryptocurrencies “Money”? 294
NationalandCentralBankDigitalCurrencies 299
TheFutureofCryptocurrencies 302
TheRestoftheStory 304
Bitcoin 304
Conclusion 307
KeyPoints 309
ReviewQuestions 310
DiscussionQuestions 310
Contents XXVII
Chapter12
RealGoodsandServicesMarkets313
TheBasics 313
AggregateSupplyCurve 313
AggregateDemandCurve 322
MacroeconomicEquilibrium 328
Don’tConfusePriceLevelIncreaseswithIncreasingInflation 330
SpendingMultiplier 331
Applications 336
TheRestoftheStory 340
DemandPull,CostPush,andSpiralInflation 340
Short-RunPhillipsCurve 344
HyperinflationandDeflation 346
ActualQuantitySuppliedAlwaysEqualsActualQuantity
Demanded 350
WhyDoesaNation’sAggregateDemandSlopeDownward? 352
Conclusion 356
KeyPoints 358
ReviewQuestions 359
DiscussionQuestions 361
Chapter13
FiscalPolicy363
TheBasics 364
WhatIsFiscalPolicy? 364
TaxesandOtherSourcesofGovernmentRevenues 365
GovernmentDeficits,Surpluses,andDebts 366
TheFiscalMultiplier,Crowding-Out,andCrowding-In 373
GovernmentSurpluses 377
AutomaticStabilizers 378
FiscalPolicyinAction 380
LagsinFiscalPolicy 381
MonetaryEffectsofFiscalPolicy 382
TheRestoftheStory 384
PuttingGovernmentDebtintoPerspective 384
ACloserLookatMonetaryEffectsofFiscalPolicy 387 Greece:ConsequencesofaMisestimatedFiscalMultiplier 391
StructuralVersusCyclicalDeficitsandSurpluses 392
Crowding-Out:WhenIsItComplete,Nonexistent,orPartial? 400
Conclusion 403
XXVIII Contents
KeyPoints 404
ReviewQuestions 405
DiscussionQuestions 406
Chapter14
BusinessCycles409
TheBasics 409
WhatAreBusinessCycles? 409
HowAreBusinessCyclesMeasured? 409
WhatCausesBusinessCycles? 411
TheRestoftheStory 415
U.S.BusinessCycles 415
U.S.BusinessCyclesfrom1947to2019 417
Conclusion 422
KeyPoints 423
ReviewQuestions 423
DiscussionQuestion 424
Chapter15 ForeignExchangeBasics425
TheBasics 425
ExchangeRates 425
TheForeignExchangeMarket 427
ParticipantsintheForeignExchangeMarket 432
CheckingAccountsNeverLeavetheCountry 436
SpotForeignExchangeMarket 438
TheRestoftheStory 439
UnderstandingSpotForeignExchangeQuotations 439
BuyingandSellingForeignExchange:BidandAskRates 440
TheMajorSegmentsoftheForeignExchangeMarket 444
Conclusion 446
KeyPoints 447
ReviewQuestions 448
DiscussionQuestion 449
Chapter16 ForeignExchangeMarkets451
TheBasics 451
MeasuringaCurrency’sValue 451
BilateralVersusEffectiveExchangeRates 452
Contents XXIX
