Macroeconomics

A Fall in the Net Capital Outflow in

the Large Open Economy

Panel (a)

shows that a downward shift in the CF

schedule reduces the demand for

loans and thereby reduces the equilib-

rium interest rate. Panel (b) shows

that the level of the net capital out-

flow falls. Panel (c) shows that the

real exchange rate appreciates, and

net exports fall.

F I G U R E

5 - 2 3

Real interest

rate, r

Real

exchange

rate,

e

Net exports, NX

CF

2

CF

1

NX

2

e

2

e

1

NX

1

2. ... 

causes the 

interest

rate to 

fall, ... 

3. ... the

exchange

rate to

rise, ...

S

I

+ CF

r

CF(r)

NX(

e)

CF

Net capital

outflow, CF

Loanable funds, S, I 

+ CF

r

1

r

2

4. ... and 

net exports 

to fall.

e

2

e

1

(a) The Market for Loanable Funds

(b) Net Capital Outflow

(c) The Market for Foreign Exchange

1. A fall in net

capital outflow ...

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162

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P A R T   I I

Classical Theory: The Economy in the Long Run

M O R E   P R O B L E M S   A N D   A P P L I C A T I O N S

1.

If a war broke out abroad, it would affect the

U.S. economy in many ways. Use the model of

the large open economy to examine each of the

following effects of such a war. What happens in

the United States to saving, investment, the trade

balance, the interest rate, and the exchange rate?

(To keep things simple, consider each of the fol-

lowing effects separately.)

a. The U.S. government, fearing it may need to

enter the war, increases its purchases of mili-

tary equipment.

b. Other countries raise their demand for

high-tech weapons, a major export of the

United States.

c. The war makes U.S. firms uncertain about

the future, and the firms delay some

investment projects.

d. The war makes U.S. consumers uncertain

about the future, and the consumers save

more in response.

e. Americans become apprehensive about travel-

ing abroad, so more of them spend their vaca-

tions in the United States.

f. Foreign investors seek a safe haven for their

portfolios in the United States.

2.

On September 21, 1995, “House Speaker Newt

Gingrich threatened to send the United States

into default on its debt for the first time in the

nation’s history, to force the Clinton Administra-

tion to balance the budget on Republican

terms” (New York Times, September 22, 1995, 

p. A1). That same day, the interest rate on 

30-year U.S. government bonds rose from 6.46

to 6.55 percent, and the dollar fell in value from

102.7 to 99.0 yen. Use the model of the large

open economy to explain this event.

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163

Unemployment

A man willing to work, and unable to find work, is perhaps the saddest sight

that fortune’s inequality exhibits under the sun.

—Thomas Carlyle

6

C H A P T E R

U

nemployment is the macroeconomic problem that affects people most

directly and severely. For most people, the loss of a job means a reduced

living standard and psychological distress. It is no surprise that unem-

ployment is a frequent topic of political debate and that politicians often claim

that their proposed policies would help create jobs.

Economists study unemployment to identify its causes and to help

improve the public policies that affect the unemployed. Some of these poli-

cies, such as job-training programs, help people find employment. Others,

such as unemployment insurance, alleviate some of the hardships that the

unemployed face. Still other policies affect the prevalence of unemployment

inadvertently. Laws mandating a high minimum wage, for instance, are wide-

ly thought to raise unemployment among the least skilled and experienced

members of the labor force.

Our discussions of the labor market so far have ignored unemployment. In

particular, the model of national income in Chapter 3 was built with the

assumption that the economy is always at full employment. In reality, not every-

one in the labor force has a job all the time: in all free-market economies, at any

moment, some people are unemployed.

Figure 6-1 shows the rate of unemployment—the percentage of the labor

force unemployed—in the United States since 1950. Although the rate of

unemployment fluctuates from year to year, it never gets even close to zero. The

average is between 5 and 6 percent, meaning that about 1 out of every 18 peo-

ple wanting a job does not have one.

In this chapter we begin our study of unemployment by discussing why

there is always some unemployment and what determines its level. We do not

study what determines the year-to-year fluctuations in the rate of unemploy-

ment until Part Four of this book, which examines short-run economic fluc-

tuations. Here we examine the determinants of the natural rate of

unemployment

—the average rate of unemployment around which the

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economy fluctuates. The natural rate is the rate of unemployment toward

which the economy gravitates in the long run, given all the labor-market

imperfections that impede workers from instantly finding jobs.