Part I: Foundations

We present the main theoretical tools used by macroeconomists. Chapters 1-8 are written by the core authors.

The Subject Matter

We describe the evolution of macroeconomics from its birth as a field in the 1930s to today. The emphasis is on how macroeconomics has responded to current events to develop new theories and data sources to expand our understanding and address the issues of the day.

A Macro Framework

This chapter presents key macroeconomic data and explains why macroeconomic theories must have particular features in order to be consistent with these facts.

The Solow Model

Modern macroeconomic theory has its roots in the Solow model of growth. We start there and will build towards cutting-edge analysis.

Dynamic Optimization

Presents the mathematical tools of dynamic optimization that are heavily used in most macroeconomic modeling. Particular emphasis is placed on infinite horizon models and dynamic programming using recursive methods. We introduce the Neoclassical Growth Model building on the Solow model from the previous chapter.

Dynamic Competitive Equilibrium

Most economies rely heavily on markets to allocate resources. Here we describe the workhorse perfect competition model of market transactions in a dynamic economy.

Welfare

In an ideal setting, the outcome from a market economy is socially optimal in the sense of Pareto optimality. We prove this result and then describe the various ways that markets can be imperfect, resulting in suboptimal outcomes and creating a role for public policy interventions.

Uncertainty

We now introduce risk and uncertainty into our analysis. We present the mathematical tools that are used to study risk in macroeconomic models. We then extend our analysis of the economy to include uncertain incomes and risky production possibilities.

Empirical strategies and quantitative macroeconomics

This chapter gives an overview of the methods that macroeconomists use to interpret data, evaluate theoretical models, and construct quantitative descriptions of the economy. We pay particular attention to calibration as a widely used technique in quantitative macro: we describe its relationship to structural estimation and we discuss the considerations in using micro-founded models as opposed to statistical models.

Part II: Applications

Consumption

by Gianluca Violante

The data show that for most consumers their level of consumption is very sensitive to changes in income and insensitive to changes in interest rates. The basic theory of consumption presented in Part I has the opposite prediction. This chapter therefore presents a richer model of consumption that better aligns with the facts.

Labor Supply

by Richard Rogerson and Gianluca Violante

How much do people work, and who works how much? How do these features vary across time and space? This chapter presents a basic theory of consumption and labor choice that can rationalize the observations.

Growth

by Timo Boppart and Pete Klenow

There has been steady income growth in advanced economies since the Industrial Revolution and there are now large differences in average income across countries. These facts have huge importance to human welfare, what explains them? A first set of explanations hinges on the accumulation of more materials and tools and working harder. The chapter explains that these forces can only explain a small part of the facts. The accumulation of knowledge is key and the chapter presents the standard framework for modeling investments in knowledge.

Real Business Cycles

by Kurt Mitman

This chapter introduces facts on business cycle fluctuations and presents theories used to analyze business cycles. Here we focus on those theories that assume perfect adjustment of prices and defer our discussion of Keynesian theories to a later chapter.

Government and Public Policies

by Marina Azzimonti, Jonathan Heathcote, and Kjetil Storesletten

To this point the book has said little about the role of government in the economy despite the fact that governments control a large fraction of the resources in many economies. This chapter describes the tradeoffs governments face when raising tax revenues and describes the theory of optimal taxation.

Asset Prices

by Monika Piazzesi and Martin Schneider

On the whole, the volatility of asset prices is surprisingly high and even despite this the average returns to risky assets exceeds those on safe assets by a surprisingly large amount. This chapter introduces the core theories of asset pricing and explains how they relate to these patterns in the data.

Money

by Andreas Hornstein and Per Krusell

This chapter develops models where money plays a role and where prices are flexible. It discusses (in)determinacy of equilibria, monetary policy rules, and the so-called cashless limit.

Nominal Frictions and Business Cycles

by Alisdair McKay and Morten Ravn

Empirically, changes in the money supply lead to changes in the level of economic activity. In this chapter we develop the workhorse New
Keynesian model of business cycles that is used to understand the effects of monetary policy and its use as a stabilization tool.

Credit Market Frictions

by Vincenzo Quadrini

Large collapses in economic activity, such as the Great Depression or the Global Financial Crisis of 2008, are often associated with problems in credit markets. This chapter extends our analysis of the economy to incorporate frictions in borrowing and lending relationships, which allows us to understand how credit market problems degrade economic performance

Frictional Labor Markets

by Toshihiko Mukoyama and Aysegul Sahin

One of the most-often cited macroeconomic statistics is the unemployment rate. Moreover, unemployment spells can have important consequences for the welfare of individual workers. Understanding this important topic requires moving beyond the frictionless labor market model we started from in order to explain why some individuals are able and willing to work yet remain unemployed.

Heterogeneous Consumers

by Per Krusell and Victor Rios-Rull

Households are vastly different in their levels of income, wealth, and consumption. What explains these differences? This chapter presents the main explanations of economic inequality.

Heterogeneous Firms

by Toshihiko Mukoyama

Much like households are heterogeneous, firms too are vastly different in the number of workers they employee and the amount of capital they control. This chapter presents facts on the distribution of firms and discusses the reasons that this heterogeneity among firms may or may not matter for the performance of the aggregate economy.

International Macro

by Giancarlo Corsetti, Luca Dedola, and Simon Lloyd

This chapter explains how two or more economies interact with each other by trading goods and financial assets. How much do countries borrow from one another? What determines the exchange rate between their currencies and between their purchasing powers?

Emerging Markets

by Juan Carlos Hatchondo and Leo Martinez

This chapter explains how the circumstances and economic performance of emerging economies differs from advanced economies. Emerging economies face particular challenges and opportunities including a different sets of government institutions, greater difficulty in borrowing abroad, and perhaps greater exposure to volatile commodity prices. The chapter pays particular attention to understanding the causes and consequences of sovereign default.

Sustainability

by John Hassler, Per Krusell, Conny Olovsson

Climate change could very likely be the most consequential macroeconomic issue of the twenty-first century. This chapter presents facts on carbon emissions and warming and then introduces a macroeconomic model that draws a link from economic activities to carbon emissions to warming. Such a model allows for the analysis of public policies aimed at reducing emissions.