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1 This page intentionally left blank ADVANCEDMACROECONOMICSF ourth EditioniThe McGraw-Hill Series in EconomicsESSENTIALS OFECONOMICSBrue, McConnell, and FlynnEssentials of EconomicsSecond EditionMandelEconomics: The BasicsFirst EditionSchillerEssentials of EconomicsEighth EditionPRINCIPLES OF ECONOMICSC olanderEconomics,Microeconomics, andMacroeconomicsEighth EditionFrank and BernankePrinciples of Economics,Principles ofMicroeconomics, Principlesof MacroeconomicsFourth EditionFrank and BernankeBrief Editions: Principles ofEconomics, Principles ofMicroeconomics, Principlesof MacroeconomicsSecond EditionMcConnell, Brue, and FlynnEconomics,Microeconomics,Macroecono micsNineteenth EditionMcConnell, Brue, and FlynnBrief Editions.

2 Microeconomics andMacroeconomicsFirst EditionMillerPrinciples ofMicroeconomicsFirst EditionSamuelson and NordhausEconomics,Microeconomics, andMacroeconomicsNineteenth EditionSchillerThe Economy Today, TheMicro Economy Today, andThe Macro Economy TodayTwelfth EditionSlavinEconomics,Microeconomics, andMacroeconomicsTenth EditionECONOMICS OF SOCIALISSUESG uellIssues in Economics TodayFifth EditionSharp, Register, and GrimesEconomics of Social IssuesNineteenth EditionECONOMETRICSG ujarati and PorterBasic EconometricsFifth EditionGujarati and PorterEssentials of EconometricsFourth EditionMANAGERIAL ECONOMICSBayeManagerial Economics andBusiness StrategyEighth EditionBrickley, Smith, andZimmermanManagerial Economics andOrganizational ArchitectureFifth EditionThomas and MauriceManagerial EconomicsTenth EditionINTERMEDIATEECONOMICSB ernheim and WhinstonMicroeconomicsFirst EditionDornbusch, Fischer.

3 AndStartzMacroeconomicsEleventh EditionFrankMicroeconomics andBehaviorEighth EditionADVANCED ECONOMICSR omerAdvanced MacroeconomicsFourth EditionMONEY AND BANKINGC ecchetti and SchoenholtzMoney, Banking, andFinancial MarketsThird EditionURBAN ECONOMICSO SullivanUrban EconomicsSeventh EditionLABOR ECONOMICSB orjasLabor EconomicsFifth EditionMcConnell, Brue, andMacphersonContemporary LaborEconomicsNinth EditionPUBLIC FINANCER osen and GayerPublic FinanceNinth EditionSeidmanPublic FinanceFirst EditionENVIRONMENTALECONOMICSF ield and FieldEnvironmental Economics:An IntroductionFifth EditionINTERNATIONALECONOMICSA ppleyard, Field, and CobbInternational EconomicsSeventh EditionKing and KingInternational Economics,Globalization, and Policy.

4 A ReaderFifth EditionPugelInternational EconomicsFourteenth EditioniiADVANCEDMACROECONOMICSF ourth EditionDavid RomerUniversity of California, BerkeleyiiiRomer-1820130rom11374 fm i-xxFebruary 17, 20118:12ivADVANCED MACROECONOMICS, FOURTH EDITIONP ublished by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc.,1221 Avenue of the Americas, New York, NY, 10020. Copyrightc 2012 byThe McGraw-Hill Companies, Inc. All rights reserved. Previous editionsc 2006, 2001,and 1996. No part of this publication may be reproduced or distributed in any form orby any means, or stored in a database or retrieval system, without the prior writtenconsent of The McGraw-Hill Companies, Inc.

5 , including, but not limited to, in anynetwork or other electronic storage or transmission, or broadcast for ancillaries, including electronic and print components, may not be available tocustomers outside the United book is printed on acid-free 978-0-07-351137-5 MHID 0-07-351137-4 Vice President & Editor-in-Chief:Brent GordonVice President EDP/Central Publishing Services:Kimberly Meriwether DavidPublisher:Douglas ReinerMarketing Manager:Dean KarampelasManaging Developmental Editor:Christina KouvelisEditorial Coordinator:Alyssa OtternessProject Manager:Robin A.

6 ReedDesign Coordinator:Margarite ReynoldsCover Designer:Studio Montage, St. Louis, MissouriBuyer:Nicole BaumgartnerMedia Project Manager:Balaji SundararamanCompositor:MPS Limited, a Macmillan Lucida BrightPrinter:R. R. DonnelleyLibrary of Congress Cataloging-in-Publication DataRomer, macroeconomics / David Romer. 4th 978-0-07-351137-51. Macroeconomics. I. 2012339 ChristyvThis page intentionally left blank ABOUT THE AUTHORD avid Romeris the Royer Professor in Political Economy at the Univer-sity of California, Berkeley, where he has been on the faculty since is also co-director of the program in Monetary Economics at the NationalBureau of Economic Research.

7 He received his from Princeton Univer-sity and his from the Massachusetts Institute of Technology. He hasbeen on the faculty at Princeton and has been a visiting faculty memberat and Stanford University. At Berkeley, he is a three-time recipientof the Graduate Economic Association s distinguished teaching and advis-ing awards. He is a fellow of the American Academy of Arts and Sciences,a former member of the Executive Committee of the American EconomicAssociation, and co-editor of theBrookings Papers on Economic of his recent research focuses on monetary and fiscal policy; this workconsiders both the effects of policy on the economy and the determinantsof policy.

8 His other research interests include the foundations of price stick-iness, empirical evidence on economic growth, and asset-price volatility. Heis married to Christina Romer, with whom he frequently collaborates. Theyhave three children, Katherine, Paul, and page intentionally left blank CONTENTS IN BRIEFI ntroduction1 Chapter 1 THE SOLOW GROWTH MODEL6 Chapter 2 INFINITE-HORIZON ANDOVERLAPPING-GENERATIONSMODELS49 Chapter 3 ENDOGENOUS GROWTH101 Chapter 4 CROSS-COUNTRY INCOMEDIFFERENCES150 Chapter 5 REAL-BUSINESS-CYCLE THEORY189 Chapter 6 NOMINAL RIGIDITY238 Chapter 7 DYNAMIC STOCHASTIC GENERAL-EQUILIBRIUM MODELS OFFLUCTUATIONS312 Chapter 8 CONSUMPTION365 Chapter 9 INVESTMENT405 Chapter 10 UNEMPLOYMENT456 Chapter 11 INFLATION AND MONETARYPOLICY513 Chapter 12 BUDGET

9 DEFICITS AND FISCALPOLICY584 EpilogueTHE FINANCIAL ANDMACROECONOMIC CRISIS OF 2008 AND BEYOND644 References649 Indexes686ixThis page intentionally left blank CONTENTSP reface to the Fourth EditionxixIntroduction1 Chapter 1 THE SOLOW GROWTH Basic Facts about Economic Dynamics of the Impact of a Change in the Saving Solow Model and the Central Questions ofGrowth Environment and Economic Growth37 Problems45 Chapter 2 INFINITE-HORIZON ANDOVERLAPPING-GENERATIONSMODELS49 Part ATHE RAMSEY CASS KOOPMANS Behavior of Households and Dynamics of the Balanced Growth Effects of a Fall in the Discount Effects of Government Purchases71 Part BTHE DIAMOND Dynamics of the Possibility of Dynamic in the Diamond Model92 Problems93 Chapter 3 ENDOGENOUS and Model without General Nature of Knowledge and the Determinants ofthe Allocation of Resources to R& Romer Application: Time-Series Tests ofEndogenous Growth Application.

10 Population Growth andTechnological Change since 1 of Knowledge Accumulation and theCentral Questions of Growth Theory143 Problems145 Chapter 4 CROSS-COUNTRY the Solow Model to Include Application: Accounting for Cross-CountryIncome Application: Social Infrastructure andCross-Country Income Social in Growth Rates178 Problems183 Chapter 5 REAL-BUSINESS-CYCLE : Some Facts about Overview of Business-Cycle Baseline Real-Business-Cycle Special Case of the the Model in the General Application: Calibrating a Real-Business-Cycle Application: Money and the Baseline Real-Business-Cycle Model226 Problems233 Chapter 6 NOMINAL RIGIDITY238 Part AEXOGENOUS NOMINAL Baseline Case: Fixed Rigidity, Wage Rigidity, and Departures fromPerfect Competition in the Goods and Application: The Cyclical Behavior of theReal a Usable Model with Exogenous NominalRigidity255 Part BMICROECONOMIC FOUNDATIONS OF INCOMPLETENOMINAL Model of Imperfect Competition and Small Frictions Enough?