Global Macroeconomics


The modules presented here have been upgraded to work directly in html. The upgraded versions do not keep score for you and make you answer the tests before seeing the answers provided. But they are much easier to use than the modules created in DOS, which are still provided and will work directly Windows XP and in the newer versions of Windows and on Apple and Linux machines using DOS-Box. To use the upgraded modules, simply click on the relevant links.


1. The Dimensions of Economic Activity

This lesson introduces the notions of capital and income and explains the relationship between stocks and flows. It then develops the ideas of output and income and depreciation together with the concepts of gross and net investment. Gross National Product and Net National Product are defined. The role of savings in determining the growth of capital stock and income is then explained and other necessary conditions for economic growth to occur are noted. A brief discussion of issues regarding efficiency follows in the HTML version. Then the reasons why people hold money are explored along with the distinction between real and nominal magnitudes. Examples of real and nominal GNP, money holdings and wages are plotted. The lesson ends with a discussion of what is meant by the term inflation.

New HTML Version (DEA.html -- 1k)
Data for HTML Version (deadata.xls -- 355k)
Figures in HTML Version (deafigs.pdf -- 355k)
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PDF Version (deagd.pdf--109k).

2. Interest Rates and Asset Values

This lesson starts by explaining what interest rates are and then introduces the concept of present value. This leads to discussions of what assets are and of the relationship between the prices of assets and the rate of interest. The effects of unanticipated inflation on the wealth positions of debtors and creditors is then analyzed and the concept of the realized real interest rate is introduced. The lesson then considers the effects of anticipated inflation on market interest rates and explains the relationship between real and nominal interest rates and the expected rate of inflation. After a brief discussion of the concept of indexing, the relationships between interest rates and actual inflation rates in a number of countries are plotted and analyzed.

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PDF Version (iavgd.pdf--98k).

3. Money and Inflation

This lesson begins with a review of what money is and why people hold it. It is noted that the government must finance its expenditures by either levying taxes, selling bonds to the public or printing money. Price-level determination is then analyzed using standard supply and demand analysis for nominal money balances, with the reciprocal of the price level on the vertical axis. After presentation of the equation of exchange, inflation is shown to be a tax on money holdings with the demand for real money balances determined by the real income and the nominal interest rate. The reasons why significant inflation is bad are then outlined and the political forces driving money creation noted. The relationship between the exchange rate and the price level is then explained along with the law of one price and purchasing power parity. The concept of the real exchange rate is introduced and the forces that would be expected to determine it outlined. The discussion then turns to cost-push inflation and an analysis of the forces determining the prices firms charge and the wage rates that will emerge from union behaviour. It is shown to be against workers' interest to force wages higher and higher in the absence of monetary finance by the government. Finally, some empirical evidence on the relationship between nominal money growth and inflation is surveyed along with the effects of inflation on nominal exchange rates in the face of non-constant real exchange rates.

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4. Unemployment

This module deals with why there can be unemployment in the economy. It starts with the traditional classical analysis of the determination of wages in a particular industry and in the economy as a whole, noting that unemployment arises when wage rates are fixed at above-market levels. We then begin relaxing the traditional assumptions that workers and firms have perfect information and are homogeneous, having no influence on wages paid. First an auction theory is presented according to which unemployment arises because workers have imperfect information, mistaking movements in aggregate demand for movements in demand in their own industries. Next we develop a search model that explains the time it takes for unemployed workers to find jobs when workers and firms are non-homogeneous and imperfectly informed. A contract theory is then developed to explain why firms lay off workers in recessions rather than cut wages---firms provide workers with wage and employment stability based on seniority in return for paying lower wages. After an analysis of the Phillips curve trade-off between inflation and unemployment the module closes with a discussion of efficiency wages and insider-outsider theories of wage determination.

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5. Interest Rates and Growth

This lesson builds on the lessons entitled THE DIMENSIONS OF ECONOMIC ACTIVITY and INTEREST RATES AND ASSET VALUES to analyze the determinants of real interest rates, aggregate savings and investment, and the rates of growth of output and per capita income. Since the latter depends on population growth the economic issues involving choice of family size are also explored. The lesson begins with a review of the relationship between the aggregate capital stock and aggregate output and defines units in which the various types of capital, broadly defined to include knowledge, technology, and social institutions, can be usefully measured. It then develops a set of conditions under which the allocation of the capital stocks to various types and locations will yield maximum output. The savings-investment process and the determination of real interest rates is then analyzed under conditions where the capital stock is, alternatively, efficiently and inefficiently allocated to alternative forms and locations. A world of two large countries is then considered and the process of saving, investment and growth is analyzed when capital in each country can be owned by both countries' residents. This leads to understanding of the conditions determining the direction and magnitude of international capital flows. The analysis then focuses on the same issues viewed from the perspective of a small country that takes conditions in the rest of the world as given. The module ends with a discussion of intergenerational capital accumulation and population growth, showing the conditions determining the equilibrium growth rate of per capita income. The nature and desirability of government policies to increase per capita income growth are then considered.

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6. Asset Markets

This lesson builds on the lesson entitled INTEREST RATES AND ASSET VALUES, analyzing the nature and functioning of asset markets. The distinction is first made between the markets for the services of capital and the markets for ownership of the capital itself. Market failure with respect to one or both of these markets in certain cases is noted and explained. The idea of capital gains is then developed, leading to a discussion of what is meant by the term speculation. The concept of market efficiency together with the meaning of the term market fundamentals and the notion of speculative bubbles is then discussed. This leads into a discussion of the problem of portfolio selection, the principle of diversification, and the evaluation of risk. These concepts are then applied to the investment decision problems of the individual asset holder.

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7. The Foreign Exchange Market

This lesson uses the concepts developed in the lessons entitled INTEREST RATES AND ASSET VALUES and ASSET MARKETS to analyze the foreign exchange market. First, the terms foreign exchange and foreign exchange market are explained. The lesson then turns to the concepts of spot and forward exchange, paying particular attention to the purpose of forward markets and to the meanings of the terms, forward discount, hedging, arbitrage, forward cover and speculation. Then efficient markets and interest parity conditions are developed and the relationship between domestic and foreign market interest rates is explained. Using the relationship between real and nominal interest rates and expected inflation, this analysis is then extended to consider the relationship between domestic and foreign real interest rates and the constraint it imposes on domestic government policy. Finally, some data on forward and spot exchange rates, interest rates and inflation rates for several countries are plotted and analyzed.

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8. Small Open Economy Equilibrium I: The Balance of Payments and the Exchange Rate

This lesson draws on the basic concepts developed in the previous modules in the sequence. It explains the balance of payments accounts and their components, both as accounting identities and desired magnitudes. After explaining the concept of balance of payments equilibrium, the relationship between the desired levels of the balance of payments components and the equality of aggregate demand and supply is developed. The nature of the process by which the desired net capital flow and the desired current account balance (and hence, aggregate demand and supply) are brought into equality is then explored under conditions of full employment and flexible exchange rates and less than full employment with fixed prices and fixed exchange rates. Evidence as to the relationships between income, the exchange rate and the current account balance observed in the real world is then presented and interpreted.

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9. Small Open Economy Equilibrium II: Monetary Policy Under Flexible Exchange Rates

This lesson draws on the basic concepts developed in the previous modules in the sequence, exploring the conditions of equilibrium of the small open economy under flexible exchange rates and the operation of monetary policy under a flexible exchange rate regime. It develops the traditional IS-LM model of open economy equilibrium under conditions where the real interest rate is fixed in the rest of the world. The analysis focuses first on the less-than-full-employment case where the domestic price level is fixed and then on the full-employment case with price level flexibility. A full-employment variant of the IS-LM graphing is developed with the price level on the horizontal axis and the real interest rate on the vertical one. The basic result that emerges is that domestic output is determined by the condition of domestic asset equilibrium and the world real interest rate under less-than-full-employment conditions and the domestic price level is determined by condition of asset equilibrium and the world interest rate when there is price level flexibility and full employment. In both cases the nominal and real exchange rates adjust endogenously to maintain flow or real goods market equilibrium. Monetary policy is effective in manipulating output and/or prices under flexible exchange rates.

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10. Small Open Economy Equilibrium III: Monetary Policy Under Fixed Exchange Rates

This lesson continues the analysis of the previous module, focusing on the equilibrium of the small open economy and the operation of monetary policy under fixed exchange rates. It begins with an overview of the conditions of equilibrium. The process of money creation is then explored in detail, followed by separate analyses of the less-than-full-employment and full-employment cases. The same IS-LM-ZZ and XX-MM-ZZ tools used in the previous model are used again here. Finally, the nature and causes of balance of payments disequilibria are considered. The basic result that emerges is that domestic output and prices are determined by the condition of flow equilibrium and the world interest rate when the exchange rate is fixed---this equilibrium is given by the intersection of the IS (or XX) and ZZ curves. The domestic money supply then adjusts through changes in the official stock of foreign exchange reserves in response to domestic residents' attempts to maintain portfolio equilibrium at these levels of output and prices. This adjustment drives the LM (or MM) curve through the IS-ZZ (or XX-ZZ) intersection. The money supply will thus be independent of the actions of the authorities although they can control the stock of foreign exchange reserves by using open market operations in domestic bonds to force home residents to adjust their portfolios by purchasing and selling assets abroad.

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11. Small Open Economy Equilibrium IV: Fiscal Policy

This lesson draws on the basic concepts developed in the previous modules in the sequence. It begins with an exposition of standard Keynesian fiscal policy and then turns to modern criticisms of it and the rebuttals to those criticisms. First, the concept of permanent income is introduced and its implications for the effects of tax cuts on consumption and aggregate demand examined. After setting out the government's budget constraint the effects of a tax cut financed by printing money are analyzed. This then leads to an analysis of bond finance and Ricardian equivalence. The effects of liquidity constraints are then considered followed by the intergenerational effects of bond-financed tax cuts. The module closes with a discussion of the crowding-out effects of government expenditure policy.

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12. Small Open Economy Equilibrium V: Additional Policy Issues

This lesson completes the subsequence dealing with small-open-economy equilibrium. It begins by extending the analysis to encompas commercial policy (tariffs and export subsidies) and the effects of devaluations and revaluations of pegged exchange rates. Then it examines the forces that determine the time path of the full-employment equilibrium real exchange rate. This leads to a discussion of the phenomenon of exchange rate overshooting in the short-run when domestic output and output prices cannot adjust to the effects of exchange rate changes induced by shocks to the demand and supply of money. The effects of monetary policy on real and nominal interest rates are considered next along with the effects of direct foreign exchange market intervention on the nominal exchange rate. The theory of purchasing power parity is then explained and evaluated, followed by an analysis of the implications of rational expectations for the conduct of monetary policy.

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13. Big Open Economy Equilibrium

This lesson analyzes big- as well as small-country equilibrium in a world either of one big country and one small one, or two big countries, one of which may be an aggregate of small countries. It begins with one big country and one small one, analyzing effects of shocks in the big country and the impact of these shocks on, and response by, the small country. It then goes on to analyze two-big-economy equilibrium under commodity monetary standards where, alternatively, both countries are on a gold standard or one country is on a gold standard and the other is on a silver standard. Next, the focus shifts to a two-big country situation where one country is the key-currency country and the other is an aggregate of peripheral countries, all of which peg their currencies to the key-currency. The effects of real and monetary shocks in the key-currency country on the rest of the world are then analyzed. Finally, the focus shifts to a two-big-country situation where one big country is an aggregation of small countries and all countries adopt flexible exchange rates. The effects of big-country shocks on the home economy and on the rest of the world under alternative rest-of-world responses are analyzed.

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14. Conducting Monetary Policy

This lesson concludes the series by examining the practical issues and problems involved in implementing monetary policy in big countries and small ones. After outlining the "nightmare" central bankers face the lesson goes on to examine the past mistakes, big and small, that have been made by central banks. It then discusses the Taylor rule, noting that it is appropriate for big economies but not small open ones. After discussing the "orderly markets approach" to monetary policy, which seems to be quite common, the lesson ends with a discussion of policy coordination problems faced by big open economies and the consequences when that coordination fails.

An HTML Version -- no DOS based module is available. (CMP.html -- 1.4k)


Students should also find useful the three essays in

John E. Floyd, Expositional Essays in Macroeconomics (eemac.ps--751k), Manuscript, University of Toronto, 2002 [ PDF Version (eemac.pdf--378k)].


Instructions Regarding Use:

As noted above, the upgraded html versions of the modules work directly with your browser. The discussion below refers to the DOS-based modules which are still provided for anyone wanting to use them.

The DOS-based module files that are downloaded from this site are self-extracting zip files of the form xxxuz.exe. They can be unzipped in a DOS (or Command) window in MS-Windows. The easiest procedure is to run each module off a floppy disk in Drive A:. When you download the module, download it to the floppy disk. You then have three options:

You can also copy the module to a directory on your C-drive and unzip and run it there by any of the three methods above.

On Mac-OS X Machines

A former student of mine, Eric Wayman, has figured out how to run the modules on Mac OS X machines using DOSBox. This also enables them to run on Windows Vista and Windows 7, which no longer support MS Dos. I am pleased to make available Eric's instructions.

Additional Instructions Regarding Modules and Guides

A "readme" file is available that will tell you more about using the modules. It is an unzipped DOS executable file. Download it, and run it in the same way that you run the module files.

Download the readme executable file (readme.exe -- 201k)

Any postscript printer will print the file xxxgd.ps containing the study guide. If your printer is not a postcript printer you can view the file xxxgd.ps and print it on a wide variety of printers using a free piece of software called GSview.

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