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Macroeconomics 6Th Edition Blanchard Solutions Manual Full Chapter PDF
Macroeconomics 6Th Edition Blanchard Solutions Manual Full Chapter PDF
ii. The chapter introduces the concept of policy mixes to achieve macroeconomic goals.
iii. The chapter introduces the use of “+” and “-” below the argument of a function to indicate the effect
of an increase in the value of the argument on the value of the function.
2. Assumptions
i. This chapter maintains the fixed price assumption of previous chapters, but relaxes the assumptions
that investment is independent of the interest rate (assumed in Chapter 3) and that nominal income is fixed
(assumed in Chapter 4). Investment is also allowed to depend on output. The point of this chapter is to
show how goods and financial markets are related and thus how output and the interest rate are
simultaneously determined.
ii. The chapter continues to assume that inventory investment is zero and that the economy is closed.
23
©2013 Pearson Education, Inc. Publishing as Prentice Hall
24 CHAPTER 5
First, relax the assumption that investment is endogenous. In terms of the framework developed thus far,
investment should depend on two factors: sales and the interest rate. A firm facing an increase in sales will
need to purchase new plant, equipment, or both to increase production. Thus, investment increases when
sales increase. An increase in the interest rate will increase the cost of borrowing needed to purchase new
plant and equipment. Thus, investment decreases when the interest rate increases. This discussion
describes an investment function of the following form:
Although the discussion suggests that investment should depend on sales, rather than income, the chapter
continues to assume that inventory investment is zero, so income equals sales.
With the revised investment function, the closed economy, goods market equilibrium condition becomes
Y=C(Y-T)+I(Y,i)+G. (5.2)
For a fixed interest rate, the Keynesian cross analysis of Chapter 3 holds with two caveats. First, demand
for goods and services (the RHS of equation (5.2)) is no longer assumed to be linear. Second, an additional
assumption is required to ensure that an equilibrium exists (i.e., that the ZZ curve intersects the 45-line).
A sufficient assumption for this purpose is that the sum of the (marginal) propensity to consume out of
income and the (marginal) propensity to invest out of income is less than one.
Equation (5.2) is called the IS relation, because (as shown in Chapter 3) goods market equilibrium is
equivalent to the condition that investment equals saving. To trace out an IS curve, start with a Keynesian
cross with a given interest rate, then vary the interest rate. A decrease in the interest rate increases the level
of investment for any level of output, so the ZZ curve shifts up and output increases. Therefore, the IS
curve has a negative slope in Y-i space (Figure 5.1).
M/P=YL(i). (5.3)
Real money market equilibrium is characterized by the same graph developed in Chapter 4, but the real
money supply (M/P) is substituted for the nominal money supply (M). The chapter maintains the short-
run assumption of a fixed price and, abstracting from details of monetary policy, assumes that M is under
the control of the central bank.
Equation (5.3) is called the LM (Liquidity-Money) relation. To graph it in Y-i space, start with the money
market equilibrium graph and vary Y. Chapter 4 demonstrated that an increase in nominal income would
increase the interest rate. Since the price is fixed, clearly an increase in real income will have the same
effect. Thus, the LM curve has a positive slope in Y-i space (Figure 5.1).
Changes in the equilibrium values of output and the interest rate (Y* and i*) can be brought about only as
the result of shifts in the IS curve, the LM curve, or both. An increase in the money supply, which shifts
the LM curve down, increases equilibrium output and reduces the equilibrium interest rate. An increase in
taxes (or a reduction in government spending), which shifts the IS curve to the left, reduces equilibrium
output and reduces the equilibrium interest rate. An increase in taxes has an ambiguous effect on
investment, since the output effect tends to reduce investment, but the interest rate effect tends to increase
it. More generally, although deficit reduction increases public (government) saving, it does not necessarily
increase investment, because private saving is endogenous.
LM
Interest Rate, i
i*
IS
Y*
Output, Y
The appendix to Chapter 5 explains how to use the IS-LM framework to recast monetary policy in terms
of interest rate rules. The monetary policy rule affects the slope of the LM curve. The traditional LM
curve is derived by varying income (and hence money demand), and tracing out the implications for the
interest rate, under the assumption that the money supply is fixed. Hence, the traditional LM curve
corresponds to a strict money-targeting rule. A strict interest rate rule, on the other hand, implies that the
LM curve is horizontal, because changes in income (and hence money demand) are fully accommodated
by the Fed at the target interest rate. An intermediate rule—some mix of money supply and interest rate
increases in response to an increase in income—produces an LM curve with a slope flatter than the
traditional LM curve, but still positively sloped.
Bush administration—lessened the severity of the recession. Although the tax cuts provided useful
stimulus, they also played the major role in creating large budget deficits in the United States. Many
economists worry about these deficits, and argue that the tax cuts should not have been made permanent.
Long after the recession of 2001, the loss of tax revenue associated with the Bush tax cuts continues to
affect government finances.
During the recession of 2001, monetary and fiscal policy both became more expansionary. In the President
Clinton’s first term, by contrast, fiscal policy became more contractionary while monetary policy became
more expansionary. The Federal Reserve supported the Clinton deficit reduction policy (a fiscal
contraction) with a monetary expansion, and interest rates fell. As a result, there was a deficit reduction
without a slowdown in growth. In fact, there was a large economic expansion—an outcome supported by
the policy mix but also aided by other factors.
V. PEDAGOGY
1. Points of Clarification
i. The Meaning of the IS and LM Curves. The derivation of the IS and LM curves will take time for
students to understand. It is important to emphasize that each point on the IS curve represents an
equilibrium in the goods market and each point on the LM curve represents an equilibrium in the money
market. In other words, the level of Y on the IS curve associated with any given interest rate is given by
the intersection of the Keynesian cross for that interest rate. Likewise, the value of i on the LM curve
associated with any given level of output is given by the intersection of (real) money supply and (real)
money demand (given the level of output) in the money market equilibrium diagram. Money demand refers
to a portfolio decision, the amount of fixed wealth that the nonbank public desires to hold in money as
opposed to bonds. Money demand does not refer to the demand for income or wealth.
ii. The Interest Rate and Shifts of the IS and LM Curves. Students may wonder why an increase
in the interest rate does not shift the IS curve, since the interest rate affects investment, or the LM curve,
since the interest rate affects money demand. It is worthwhile to emphasize that the effects of the interest
rate on the goods market and the money market are reflected in the slopes of the IS and LM curves. Output
and the interest rate are endogenous variables. Only changes to variables exogenous to the IS-LM model
can shift the curves.
iii. The Interest Rate and the Effectiveness of Fiscal Policy. The effect of fiscal policy on the
interest rate limits the ability of fiscal policy to influence output. To reinforce this point, it is worthwhile
to compare the output effects of an increase in G in the Keynesian cross model (modified to include
endogenous investment) to the effects of the same policy in the IS-LM model. An increase in G shifts the
IS curve to the right. The horizontal shift at the initial interest rate is the change in output from the
Keynesian cross (see Figure 5.2). Clearly this is larger than the change in output from the IS-LM model,
unless the LM curve is horizontal. In the IS-LM model, the increase in G leads to an increase in the interest
rate, which tends to reduce investment. The interest rate effect is not present in the simple Keynesian cross
model.
Figure 5.2: Fiscal Expansion in the Keynesian Cross and the IS-LM Models
LM
Interest Rate, i
Increase in Y in the
Keynesian Cross Model
IS
Increase in Y
in the
IS-LM Model
Output, Y
VI. EXTENSIONS
1. Behavioral Parameters, the Slopes of the IS and LM Curves, and Policy
Effectiveness
The text does not discuss the slopes of the IS and LM curves and the influence of behavioral parameters on
the effectiveness of policy. With respect to the slopes, the more sensitive money demand is to income
relative to the interest rate, the steeper the LM curve. Likewise, the more sensitive goods demand (C+I+G)
is to income relative to the interest rate (through investment), the steeper the IS curve.
On the effectiveness of policy, there are two options to bring out the basic points. The first option is to
choose a simple linear specification and work out the relationship between the output effect of policy and
behavioral parameters. The second option is to discuss the issue more heuristically. For example, consider
an increase in government spending, and proceed in three steps.
i. For any given interest rate, the effect of fiscal policy on output will depend on the multiplier,
modified to include endogenous investment. The larger the multiplier, i.e., the greater the
sensitivity of consumption and investment to output, the larger the initial response of output.
ii. Since an increase in G will increase Y, it will also increase the quantity of money demanded for
any interest rate, and thus increase the interest rate, in order to maintain money market equilibrium.
The increase in the interest rate will be small to the extent that money demand is not very sensitive
to income, but is very sensitive to the interest rate.
If money demand is not very sensitive to income, then the excess demand for money created by the
increase in G will be small. If money demand is very sensitive to the interest rate, the increase in
the interest rate needed to restore equilibrium in the money market will be small.
iii. Finally, the increase in the interest rate will tend to reduce investment and thus offset some of
the initial increase in output. This effect will be small to the extent that investment is not very
sensitive to the interest rate.
In sum, fiscal policy will have a greater effect on output to the extent that the multiplier is large, money
demand is not very sensitive to income, money demand is very sensitive to the interest rate, and investment
is not very sensitive to the interest rate.
One could carry out the same exercise with respect to monetary policy. An increase in the money supply
affects output by reducing the interest rate and increasing investment. Thus, an increase in the money
supply will tend to have a large effect on output when it has a large effect on the interest rate, which will
be true when money demand is not very sensitive to the interest rate. The interest rate will have a large
effect on output when investment is very sensitive to the interest rate, which calls forth the initial response
of output, and, again, when the multiplier is large. The increase in output increases the quantity of money
demanded for any interest rate and tends to increase the interest rate, offsetting some of the initial effect of
the increase in the money supply. This effect will be small when the demand for money is not very sensitive
to income.
In sum, monetary policy will have a greater effect on output to the extent that money demand is not very
sensitive to the interest rate, investment is very sensitive to the interest rate, the multiplier is large, and
money demand is not very sensitive to income.
These exercises are relatively sophisticated, but they make clear the linkages between the goods market and
the money market through the interest rate.
xxxix. Marche
de Constance
vers la Perse.
Constance n'assista pas à ce synode: il marchait
alors vers la Perse, d'où l'on craignait sans cesse [Soz. l. 2, c. 9-
une irruption. La haine de Sapor contre les 14.]
Romains croissait de plus en plus. Tant que la
religion chrétienne avait été persécutée dans Cod. Th. lib. 11,
l'empire, la Perse avait ouvert les bras aux t. 7, leg. 5.
chrétiens qui venaient y chercher un asyle. Mais
depuis la conversion de Constantin, Sapor les
regardait comme autant d'espions et de traîtres: il Aug.
de Civ. l.
18, c. 52, t. 7, p.
les accusait de favoriser les Romains, avec 535.
lesquels ils s'accordaient dans le culte. Sous ce
prétexte il les livrait aux plus affreux supplices. Les
tables ecclésiastiques donnaient les noms de Baron. an. 344.
seize mille martyrs, tant hommes que femmes[146].
Le reste était innombrable. Ces cruels traitements [Themist. or. 4,
contribuaient à fortifier les soupçons de Sapor: un p. 58.
grand nombre de fidèles se réfugiaient dans les
villes romaines, et par une sorte de reflux la Chron. Alex.
persécution les ramenait dans les mêmes vel. Pasch. p.
contrées, d'où la persécution les avait chassés. 289.
Constance s'avança jusqu'à Nisibe[147], où se
rendait sans doute une partie de ces pieux fugitifs. Ducange,
Mais on ne voit pas que les Perses aient cette Const. chr. p. 91
année passé le Tigre, et l'empereur revint à et 92.]
Antioche sans avoir tiré l'épée. On avait
commencé le 17 d'avril à construire à Constantinople des thermes
magnifiques, qui portèrent le nom de Constance. Il y fit transporter
d'Antioche les statues de Persée et d'Andromède.
[146] Voyez les additions au livre v, § 22.—S.-M.
[147] Il était dans cette ville le 12 mai 345.—S.-M.