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List of Figures xv List of Tables xvii Preface xix 1. Microeconomic Foundations 1 1.1 Microeconomics 1.1.1 Allocation, Feasibility, Optimality 1.1.2 Competitive Equilibrium 1.1.3 Walras’s Law 1.1.4 Fundamental Theorems of Welfare Economics 1.2 Primitives 1.2.1 Event Tree 1.2.2 Preferences 1.2.3 Technology 1.3 Bibliographic Notes 2. Consumption and Saving 11 2.1 Consumption Smoothing 2.1.1 Two Periods 2.1.2 More Periods 2.1.3 Infinite Horizon 2.2 Extensions 2.2.1 Borrowing Constraint 2.2.2 Nongeometric Discounting and Time Consistency 2.2.3 Multiple Goods 2.3 Bibliographic Notes 3. Dynamic Competitive Equilibrium 25 3.1 Representative Agent and Capital Accumulation 3.1.1 Economy 3.1.2 Firms 3.1.3 Households 3.1.4 Market Clearing 3.1.5 General Equilibrium 3.1.6 Social Planner Allocation and Pareto Optimality 3.1.7 Analysis 3.1.8 Population Growth 3.2 Overlapping Generations and Capital Accumulation 3.2.1 Economy 3.2.2 Firms 3.2.3 Households 3.2.4 Market Clearing 3.2.5 General Equilibrium 3.2.6 Analysis 3.2.7 Pareto Optimality 3.2.8 Population Growth 3.3 Bibliographic Notes 4. Risk 39 4.1 Consumption, Saving, and Insurance 4.1.1 Incomplete Markets 4.1.2 Complete Markets 4.1.3 General Case 4.2 Risk Sharing 4.2.1 Borch’s Rule 4.2.2 Aggregate and Idiosyncratic Risk 4.3 Uninsurable Labor Income Risk and Capital Accumulation 4.3.1 Economy 4.3.2 Households 4.3.3 General Equilibrium 4.4 Bibliographic Notes 5. Asset Returns and Asset Prices 55 5.1 Euler Equation 5.2 Excess Returns 5.2.1 C-CAPM 5.2.2 CAPM 5.3 Asset Prices 5.3.1 Fundamental Value 5.3.2 Bubble 5.4 Term Structure of Interest Rates 5.5 Equilibrium Asset Prices in an Endowment Economy 5.5.1 Economy 5.5.2 General Equilibrium 5.6 Bibliographic Notes 6. Labor Supply, Growth, and Business Cycles 65 6.1 Goods versus Leisure Consumption 6.1.1 One Period 6.1.2 More Periods 6.1.3 Wage Inequality and Risk Sharing 6.2 Growth 6.2.1 Exogenous Growth 6.2.2 Endogenous Growth 6.3 Business Cycles 6.3.1 Real Business Cycles 6.3.2 Sunspot-Driven Business Cycles 6.4 Bibliographic Notes 7. The Open Economy 89 7.1 Current Account and Net Foreign Assets 7.2 Real Exchange Rate 7.3 Gains From Trade 7.4 International Risk Sharing 7.5 Bibliographic Notes 8. Frictions 97 8.1 Capital Adjustment Frictions 8.1.1 Convex Adjustment Costs and Tobin’s q 8.1.2 Nonconvex Adjustment Costs 8.1.3 Irreversibility and the Option Value of Waiting 8.2 Labor Market Frictions 8.2.1 Economy 8.2.2 Firms 8.2.3 Households 8.2.4 Market Clearing and Wage Determination 8.2.5 Equilibrium 8.2.6 Constrained Pareto Optimality 8.2.7 The Case without Capital 8.2.8 A Model without Capital and Leisure 8.3 Financial Frictions 8.3.1 Net Worth and External Finance Premium 8.3.2 Collateral and Asset Prices 8.3.3 Pecuniary Externalities and Constrained Inefficiency 8.4 Bibliographic Notes 9. Money 129 9.1 Unit of Account 9.1.1 Fisher Equation 9.1.2 Interest Parity and Nominal Exchange Rate 9.2 Store of Value 9.2.1 Overlapping Generations 9.2.2 Borrowing Constrained, Infinitely Lived Households 9.3 Medium of Exchange 9.3.1 Matching Frictions 9.3.2 Money in the Utility Function 9.3.3 Cash-in-Advance Constraint 9.4 The Price of Money 9.5 Bibliographic Notes 10. Price Setting and Price Rigidity 147 10.1 Price Setting 10.2 Staggered Price Setting 10.3 Price Rigidity in General Equilibrium 10.3.1 Firms 10.3.2 Households 10.3.3 Market Clearing 10.3.4 General Equilibrium 10.3.5 Analysis 10.4 Bibliographic Notes 11 The Government 161 11.1 Taxation and Government Consumption 11.2 Government Debt and Social Security 11.2.1 Government Debt with a Representative Agent 11.2.2 Government Debt with Overlapping Generations 11.2.3 Pay-as-You-Go Social Security 11.3 Equivalence of Policies 11.3.1 General Equivalence Result 11.3.2 Applications 11.4 Fiscal-Monetary Policy Interaction 11.4.1 Consolidated Government Budget Constraint 11.4.2 Seignorage Needs as Driver of Inflation 11.4.3 Inflation Effects of Government Financing 11.4.4 Game of Chicken 11.4.5 Fiscal Theory of the Price Level 11.4.6 Stability under Policy Rules 11.5 Determinate Inflation and Output 11.5.1 Flexible Prices 11.5.2 Rigid Prices 11.6 Real Effects of Monetary Policy 11.6.1 Flexible Prices 11.6.2 Rigid Prices 11.7 Bibliographic Notes 12. Optimal Policy 191 12.1 Tax Smoothing 12.1.1 Complete Markets 12.1.2 Incomplete Markets 12.1.3 Capital Income Taxation 12.1.4 Heterogeneous Households 12.2 Social Insurance and Saving Taxation 12.3 Monetary Policy 12.3.1 Friedman Rule 12.3.2 Dealing with Price Rigidity 12.4 Bibliographic Notes 13. Time Consistent Policy 215 13.1 Time Consistency and the Role of State Variables 13.2 Credible Tax Policy 13.3 Capital Income Taxation 13.3.1 Commitment Benchmark 13.3.2 No Commitment 13.4 Sovereign Debt and Default 13.4.1 Insurance 13.4.2 Borrowing with Contingent Debt 13.4.3 Borrowing with Noncontingent Debt 13.4.4 Loan Size Determinants 13.4.5 Debt Laffer Curve and Debt Overhang 13.4.6 Multiple Equilibria 13.4.7 Financial Autarky as Deterrent 13.5 Redistribution in Politico-Economic Equilibrium 13.5.1 Probabilistic Voting 13.5.2 Politico-Economic Equilibrium 13.5.3 Support for Redistribution 13.6 Monetary Policy 13.6.1 Stabilization Bias 13.6.2 Inflation Bias 13.7 Bibliographic Notes A. Mathematical Tools 241 A.1 Constrained Optimization A.2 Infinite-Horizon Dynamic Programming A.2.1 Principle of Optimality A.2.2 Uniqueness of V A.2.3 Properties of V A.3 Systems of Linear Difference Equations A.4 Bibliographic Notes B. Technical Discussions 245 B.1 Transversality Condition in InfiniteHorizon Saving Problem B.2 Representative Household B.3 Transversality Condition in InfiniteHorizon Planner Problem B.4 Nonexpected Utility B.5 Linear Rational Expectations Models B.5.1 Single Equation Model B.5.2 Multiple Equation Model B.6 Ramsey Taxation B.6.1 Primal Approach B.6.2 Dual Approach B.7 Probabilistic Voting B.8 Bibliographic Notes Bibliography 261 Author Index 283 Subject Index 289

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