Macroeconomics for managers

Macroeconomics for managers

Michael K. Evans
© 2004 by Michael K. Evans

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First published 2004 by Blackwell Publishing Ltd

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Evans, Michael K.

Macroeconomics for managers / Michael K. Evans.

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Includes bibliographical references and index.

ISBN 1-4051-0144-X (hardcover : alk. paper) – 1-4051-0145-8 (pbk. : alk. paper)

1. Managerial economics. 2. Macroeconomics. I. Evans, Michael K.

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 Contents

Preface and Acknowledgments xv

Part I: Introductory Concepts 1

Chapter 1: The Importance of Macroeconomics 3

Introduction 3
1.1 What is Macroeconomics? 5
1.2 Links Between Macroeconomics and Microeconomics 8
1.3 Current Core of Macroeconomic Theory 10
1.4 Macroeconomics – an Empirical Discipline 11
1.5 The Importance of Policy Applications 13
1.6 Positive and Normative Economics: Why Macroeconomists
Disagree 14
1.7 Roadmap of this Book 17
Key Terms and Concepts 19
Summary 19
Questions and Problems 20
Appendix: Thumbnail Sketch of the Development of Macroeconomics 22
Notes 27

Chapter 2: National Income and Product Accounts (NIPA) 28

Introduction 28
2.1 How the National Income and Product Accounts are
Constructed 28
2.2 Components of GDP: Final Goods and Services 30
2.3 Differences Between Final and Intermediate Goods and Services 36
2.4 Components of National Income 37
2.5 Balancing Items Linking GDP, NI, PI, and DI 46
vi CONTENTS

2.6 Value Added by Stages of Production: An Example 51

2.7 Inclusions and Exclusions in the NIPA Data 52
2.8 Circular Flow Between Aggregate Demand and Production 56
Key Terms and Concepts 57
Summary 58
Questions and Problems 59
Appendix: Key Macroeconomic Identities 62
Notes 63

Chapter 3: Key Data Concepts: Inflation, Unemployment, and

Labor Costs 65

Introduction 65
3.1 Measuring Inflation: Three Different Types of Indexes 65
3.2 Factors Causing the Inflation Rate to be Overstated 68
3.3 Could the Inflation Rate be Understated? 75
3.4 Different Measures of Unemployment 78
3.5 Collecting the Employment and Unemployment Data 80
3.6 The Concept of Full Employment 86
3.7 Unit Labor Costs 91
3.8 Summarizing the Economic Data: Indexes of Leading and
Coincident Indicators 96
3.9 Methods and Flaws of Seasonally Adjusted Data 97
3.10 Preliminary and Revised Data 99
Key Terms and Concepts 100
Summary 100
Questions and Problems 101
Notes 104

Part II: Aggregate Demand and Joint Determination of Output and Interest Rates 105

Chapter 4: The Consumption Function 107

Introduction 107
4.1 Principal Determinants of Consumption 108
4.2 Short-Term Links Between Consumption and
Disposable Income: The Marginal Propensity to Consume 111
4.3 Long-Term Links Between Consumption and Income:
The Permanent Income Hypothesis 114
4.4 Consumer Spending and Changes in Tax Rates 115
4.5 Importance of Cost and Availability of Credit in
the Consumption Function 119
4.6 Consumption, Housing Prices, and Mortgage Rates 122
 CONTENTS vii

4.7 Other Links Between Consumer Spending, the Rate of Interest,

and the Rate of Return 124
4.8 Credit Availability and the Stock of Debt 126
4.9 The Role of Demographic Factors and the Life Cycle Hypothesis 129
4.10 The Relationship Between Consumption and Household
Net Worth 130
4.11 The Effect of Changes in Consumer Confidence 135
4.12 Review 137
Key Terms and Concepts 138
Summary 138
Questions and Problems 139
Appendix: Historical Development of the Consumption Function 141
Notes 149

Chapter 5: Investment and Saving 151

Introduction 151
5.1 The Equivalence of Investment and Saving 151
5.2 Long-Term Determinants of Capital Spending 153
5.3 The Basic Investment Decision 155
5.4 The Cost of Capital 157
5.5 The Availability of Credit 159
5.6 The Role of Expectations 162
5.7 Lags in the Investment Function 163
5.8 The Effect of Changes in Tax Policy on Capital Spending
Decisions 164
5.9 Determinants of Exports and Imports 173
5.10 The Role of Government Saving 182
5.11 Recap: Why Investment Always Equals Saving on
an Ex Post Basis 183
Key Terms and Concepts 184
Summary 184
Questions and Problems 185
Appendix: The Theory of Optimal Capital Accumulation 187
Notes 194

Chapter 6: Determination of Interest Rates and Introduction to

Monetary Policy 195
Introduction 195
6.1 Definitions of Key Interest Rates and Yield Spreads 197
6.2 The Role of Monetary Policy 202
6.3 The Federal Reserve System 204
6.4 Determination of the Federal Funds Rate 206
6.5 Effect of Federal Reserve Policy on the Availability of Credit 212
viii CONTENTS

6.6 Determinants of Long-Term Interest Rates 213

6.7 The Difference Between Changes in Monetary Conditions and
Monetary Policy 216
6.8 Factors Causing the Yield Spread to Fluctuate 217
6.9 Transmission of Monetary Policy 221
6.10 The Importance of the Yield Spread as a Predictive Tool 224
6.11 Why Targeting Interest Rates Doesn’t Always Work:
The Conundrum 227
Key Terms and Concepts 228
Summary 229
Questions and Problems 230
Notes 232

Chapter 7: Joint Determination of Income and Interest Rates:

The IS/LM Diagram 234

Introduction 234
7.1 Review of the Effect of Changes in Interest Rates and
Income on Saving and Investment 235
7.2 Equilibrium in the Goods Market 237
7.3 Derivation of the IS Curve 238
7.4 Slope of the IS Curve under Varying Economic Conditions 242
7.5 Factors that Shift the IS Curve 242
7.6 The Demand for Money: Liquidity Preference and
Loanable Funds 244
7.7 Equilibrium in the Assets Market: Derivation of the LM Curve 246
7.8 Slope of the LM Curve under Varying Economic Conditions 247
7.9 The IS/LM Diagram and Introduction to Monetary and
Fiscal Policy 250
7.10 The IS/LM Diagram in Booms and Recessions 252
7.11 Factors that Shift the IS and LM Curves 253
7.12 A Numerical Example: Solving for Income and
Interest Rates using the IS/LM Model 254
Key Terms and Concepts 262
Summary 262
Questions and Problems 263
Notes 266

Part III: Aggregate Supply: Inflation, Unemployment, and Productivity 267

Chapter 8: Causes of and Cures for Inflation 269

Introduction 269
8.1 In the Long Run, Inflation is a Monetary Phenomenon 271
 CONTENTS ix

8.2 In the Short Run, Inflation is Determined by

Unit Labor Costs: The Price Markup Equation 272
8.3 Monetary Policy and the Role of Expectations 280
8.4 Determinants of Changes in Unit Labor Costs 284
8.5 Malign and Benign Supply Shocks 291
8.6 Lags in Determining Wages and Prices 295
8.7 The Beginnings and Ends of Hyperinflation 297
8.8 Summary of Why Inflation Remained Low in
the 1990s – and What Might Occur in the Future 300
Key Terms and Concepts 304
Summary 304
Questions and Problems 305
Appendix: Historical Explanations of Inflation: The Rise and
Fall of the Phillips Curve 307
Notes 314

Chapter 9: Why High Unemployment Persists 316

Introduction 316
9.1 The Basic Labor Market Model 317
9.2 Real Growth and Unemployment: Okun’s Law 322
9.3 Why Stimulatory Monetary and Fiscal Policy Might Not
Reduce Unemployment 324
9.4 Theories Based on Labor Market Imperfections: Summary 326
9.5 Sticky Prices and Nominal Wage Rates 329
9.6 Sticky Real Wage Rates: Efficiency Wages 332
9.7 Sticky Real Wage Rates: Insider/Outsider Relationships 334
9.8 Barriers to Market-Clearing Wages: The Minimum Wage 337
9.9 The Wedge Between Private and Social Costs of Labor 348
9.10 High Unemployment Rates and Hysteresis 351
9.11 The Structuralist School 352
Key Terms and Concepts 357
Summary 357
Questions and Problems 358
Notes 361

Chapter 10: Aggregate Supply, the Production Function, and

the Neoclassical Growth Model 363

Introduction 363
10.1 Productivity Growth and the Standard of Living 364
10.2 The Long-Term Historical Growth Record 368
10.3 The Aggregate Production Function and Returns to Scale 372
10.4 The Cobb-Douglas Production Function 373
10.5 Why Growth Differs among Nations: The Importance of
Saving and Investment 374
x CONTENTS

10.6 Other Factors Affecting Growth: The Framework of

Growth Accounting 376
10.7 Causes of Growth in the US Economy 378
10.8 The Worldwide Slowdown in Productivity after 1973 381
10.9 The Neoclassical Growth Model and the Slowdown of
Mature Economies 387
10.10 Endogenous Growth Theory and Convergence Models 388
10.11 Additional Importance of Saving and Investment 392
Key Terms and Concepts 394
Summary 394
Questions and Problems 395
Notes 397

Part IV: The International Economy 399

Chapter 11: Basic Determinants of Exports and Imports 403

11.1 The Balance Between Current and Capital Accounts 403

11.2 Fixed and Flexible Exchange Rates 408
11.3 US Exports and Imports: Empirical Review 411
11.4 Income and Price Elasticities of US Exports and Imports 413
11.5 The Repercussion Effect 419
11.6 How Serious is the Burgeoning Trade Deficit? 421
11.7 Recent Progress Toward Free Trade 428
11.8 Arguments For and Against a Trade Deficit 434
11.9 Foreign Purchases of US Assets: A Non-Event 437
Key Terms and Concepts 439
Summary 439
Questions and Problems 441
Appendix: The Theory of Comparative Advantage and
the Modern Theory of International Trade 442
Note 444

Chapter 12: International Financial Markets and

Foreign Exchange Policy 445

Introduction 445
12.1 The World Dollar Standard and Major Trends in
Other Key Currencies 446
12.2 Nominal and Real Exchange Rates 452
12.3 Measuring International Labor Costs 453
12.4 The Concept of Purchasing Power Parity 455
12.5 Factors that Determine Foreign Exchange Rates 460
 CONTENTS xi

12.6 Why Foreign Exchange Markets Overshoot Equilibrium:

The J-Curve Effect 470
12.7 Other Factors Causing Currency Rates to
Diverge from Equilibrium 475
12.8 Managed Exchange Rates: Bands and Crawling Pegs 477
12.9 Optimal Trade and Foreign Exchange Rate Policy 481
Key Terms and Concepts 483
Summary 483
Questions and Problems 484
Notes 486

Chapter 13: The Mundell-Fleming Model: Joint Determination of

Output, Interest Rates, Net Exports, and the Value of the Currency 487

13.1 Links Between Domestic and International Saving and

Investment 487
13.2 The Basic Model: Joint Determination of Real Interest Rates,
Output, Currency Value, and the Current Account Balance 489
13.3 The Mundell-Fleming Model for a Small Open Economy 492
13.4 The Repercussion Effect in the Mundell-Fleming Model 494
13.5 The Depreciation Effect in the Mundell-Fleming Model 496
13.6 Shifts in the NX and NFI Curves Caused by
Changes in Inflation and Productivity 499
13.7 Effects of the Reagan and Clinton Fiscal and Monetary Policies 500
13.8 Economic Impact of an Exogenous Change in Net Exports 504
13.9 Short- and Long-Run Effects of an Exogenous Change in
the Value of the Currency 507
Key Terms and Concepts 511
Summary 511
Questions and Problems 513
Notes 516

Chapter 14: Case Studies in International Trade 517

Introduction 517
14.1 International Trade in the European Economy 517
14.2 International Trade in the Asian Economy 527
14.3 International Trade in Latin America 539
14.4 Pros and Cons of Free Trade in an Imperfect World 545
14.5 What Factors Will Determine World Leaders of the
Twenty-First Century? 551
Summary 554
Questions and Problems 555
Note 557
xii CONTENTS

Part V: Cyclical Fluctuations 559

Chapter 15: Business Cycles 561

Introduction 561
15.1 The Long-Term Historical Record 562
15.2 Measuring the Business Cycle: The Indexes of
Leading, Coincident, and Lagging Indicators 564
15.3 Cyclical Behavior: Recurring but Not Regular 567
15.4 The Phases of the Business Cycle 572
15.5 The Role of Exogenous Shocks in the Business Cycle 577
15.6 The Role of Technology in the Business Cycle 582
15.7 The Role of Fiscal Policy in the Business Cycle 586
15.8 The Role of Monetary Policy in the Business Cycle 590
15.9 Global Transmission of Business Cycles 593
15.10 Could the Great Depression Happen Again? 594
15.11 Recap: Are Business Cycles Endogenous or Exogenous? 598
Key Terms and Concepts 600
Summary 600
Questions and Problems 601
Notes 602

Chapter 16: Cyclical Fluctuations in Components of

Aggregate Demand 605

Introduction 605
16.1 The Stock Adjustment Principle 606
16.2 Empirical Review: The Components of Capital Spending 608
16.3 The Role of Business Sentiment in Capital Spending 608
16.4 Investment in Residential Construction 612
16.5 The Role of Inventory Investment in the Business Cycle 622
16.6 Inventory Production and Control Mechanisms 627
16.7 Cyclical Patterns in Purchases of Motor Vehicles 629
16.8 Cyclical Patterns in Other Components of Consumption 634
16.9 Recap: What Determines Cyclical Fluctuations in
Aggregate Demand 635
Key Terms and Concepts 637
Summary 637
Questions and Problems 638
Notes 641

Chapter 17: Financial Business Cycles 643

Introduction 643
17.1 Cyclical Patterns of Monetary and Credit Aggregates 644
17.2 Cyclical Patterns in the Yield Spread 647
 CONTENTS xiii

17.3 Cyclical Patterns of Stock Market Prices 649

17.4 The Present Discounted Value of Stock Prices and the
Equilibrium Price/Earnings Ratio 653
17.5 Determinants of the Risk Factor 655
17.6 Impact of the Budget Ratio on Bond and Stock Returns 665
17.7 Impact of Changes in the Expected Rate of Inflation on
Bond and Stock Returns 669
17.8 Impact of Changes in Capital Gains Taxes on Stock Prices 670
17.9 Long-Term Performance of Stocks, Bonds, and Liquid Assets 672
17.10 Cyclical Fluctuations in Returns on Stocks, Bonds, and
Liquid Assets 674
17.11 Recap: The Importance of Financial Markets and
Asset Allocation 675
Key Terms and Concepts 676
Summary 676
Questions and Problems 677
Notes 679

Part VI: Policy Analysis and Forecasting 681

Chapter 18: Fiscal Policy and Its Impact on Productivity Growth 683
Introduction 683
18.1 Automatic and Discretionary Stabilizers 684
18.2 Components of the Federal Government Budget 689
18.3 Advantages and Disadvantages of Federal Budget Surpluses
and Deficits 694
18.4 The Concept of the Fiscal Dividend 699
18.5 The Role of Fiscal Policy in Determining Productivity Growth 702
18.6 Simplifying the Tax Code 705
18.7 ‘‘Saving’’ Social Security and Medicare 707
18.8 Recap: Fiscal Policy and Productivity Growth 713
Key Terms and Concepts 715
Summary 715
Questions and Problems 716
Notes 718

Chapter 19: Monetary Policy and Its Impact on Inflation and Growth 719
Introduction 719
19.1 The Overall Goals of Monetary Policy: Insure
Adequate Liquidity, Reduce Business Cycle Fluctuations, and
Keep Inflation Low and Stable 720
19.2 The Negative Effects of Higher Inflation 724
19.3 The Optimal Rate of Inflation is Not Zero 726
xiv CONTENTS

19.4 The Role of Monetary Policy in Financial Crises 730

19.5 Demand-Side Policies: Punchbowls and Preemptive Strikes 733
19.6 Supply-Side Shocks and Sticky Prices and Wages:
How the Fed Should React 736
19.7 Why Targeting Interest Rates Doesn’t Always Work:
The Conundrum Revisited 737
19.8 Budget Deficits and Monetary Policy 738
19.9 Monetary Policy in an Open Economy 740
19.10 Why Higher Inflation Leads to Lower Productivity 741
19.11 Recap: The Case for Active Monetary Policy and
Optimal Policy Rules 743
Key Terms and Concepts 746
Summary 747
Questions and Problems 748
Notes 750

Chapter 20: Macroeconomic Forecasting: Methods and Pitfalls 751

Introduction 751
20.1 Sources of Forecasting Error in Econometric Models: Summary 751
20.2 Inadequate and Incorrect Data and the Tendency to Cluster 752
20.3 Examining Exogenous Shocks: Impulse and
Propagation Revisited 756
20.4 Market Reaction to Economic Data 759
20.5 Unknown Lag Structures and the Conservatism Principle 761
20.6 Summary of Noneconometric Forecasting Methods 765
20.7 Naive Models and Consensus Surveys of Macro Forecasts 766
20.8 Using the Index of Leading Economic Indicators to
Predict the Economy 771
20.9 Survey Methods for Individual Sectors 774
20.10 Recap: How Managers Should Use Forecasting Tools 781
Key Terms and Concepts 784
Summary 784
Questions and Problems 785
Notes 787

Bibliography and Further Reading 788

Index 790
 Preface and Acknowledgments

The focus of macroeconomics has changed dramatically since I first taught this
subject in 1962. Then, crude Keynesian economics – the use of simplistic rules of
fiscal stimulus – and the Phillips curve – the tradeoff between inflation and unem-
ployment – reigned supreme, and virtually all mainstream economists thought
macroeconomic performance could be optimized by pushing the right buttons and
pulling the right levers. After the US economy fell flat on its face in the 1970s,
with four recessions in 12 years, two bouts of double-digit inflation, double-
digit unemployment rates, and a prime rate as high as 21 21 %, existing theory
was scrapped, and replaced by the doctrine of rational expectations, including
the mantra that fine tuning would never work, and the best policies were a
full-employment balanced budget and equilibrium short-term interest rates set
at the growth rate of nominal GDP. More recently, macroeconomics has focused on
the difference between short-term and long-term explanations for changes in real
GDP, inflation, and the unemployment rate. Debate still rages in certain quarters
between the ‘‘new classical’’ economists, who think all markets clear quickly in
the absence of government intervention, and the ‘‘new Keynesian’’ economists,
who think some markets clear very slowly or not at all. Yet while these debates
are of great interest to certain academics, they are generally ignored by business
managers, the audience for whom this book is addressed.
I have always thought that macroeconomics should be approached as an empiri-
cal discipline: theories that are not supported by the facts should be discarded. The
problem with this approach, of course, is that the ‘‘facts’’ frequently change. Human
beings are not machines, and they often react differently when the same situation is
repeated. In some cases, they learn by their past mistakes. In other cases, the ‘‘facts’’
are not really the same because underlying conditions have changed. Thus promul-
gating even simple rules that are designed to improve economic performance may
have unintended consequences.
The modern study of macroeconomics began with John Maynard Keynes,
who sought to cure the Great Depression while saving capitalism and democ-
racy. Even today, governments rise and fall – some at the voting booth, some
xvi PREFACE AND ACKNOWLEDGMENTS

through revolution – when governments cannot provide conditions that reason-

ably approximate full employment, price stability, and a rising standard of living.
Of course they are not always successful, but that is not really the message imparted
here. Governments will keep these goals in mind, and will implement changes in
monetary, fiscal, trade, and regulatory policies if they are not met. Business man-
agers should be aware of how these policies are likely to change – and how that
will affect their sales and profits.
Many recessions are caused entirely or primarily by exogenous shocks: wars,
energy crises, major strikes, or terrorist attacks. Obviously macroeconomists can-
not be expected to predict these variables: indeed, any economist who accurately
predicted the 9/11 terrorist attack probably would have been detained indefinitely
for prolonged questioning. That is not the only reason that macroeconomists have
never been able to predict any of the recessions in the US economy, but it is a con-
tributing factor. That pattern is likely to continue in the future. Indeed, if private
and public sector economists widely agreed that a recession was about to start, pol-
icy shifts would probably be taken to reduce if not entirely eliminate the likelihood
of an actual downturn.
Nonetheless, macroeconomics can offer valuable advice and guidance even if it
provides no hint of when these shocks will strike next. Based on how consumers,
businesses, and government policymakers react to these shocks, managers are
often able to determine how they should alter their own business plans. Often, the
biggest business mistakes are not made because of inability to foresee these shocks,
but the inability to adjust to them once they have occurred.
Recent macroeconomic textbooks have tended to focus more on the long-run
determinants of the economy, relegating short-term fluctuations to a less prominent
position: I do not follow that practice. To a certain extent, that may have been due to
a lingering belief that we do not have business cycles any more. The 2001 recession
exposed this hypothesis as a cruel mirage. The recession itself was quite mild; on an
annual basis, real GDP rose slightly in 2001, and the unemployment rate increased
less than 2%, the smallest gain in any official recession. Nonetheless, the decline
of 50% in the S&P 500 index and 75% in the Nasdaq composite index could not be
so easily ignored, and set the stage for an extended period of sluggish growth. As
capital spending failed to recover, and as the trade deficit widened at record rates,
more and more economists – and politicians – became concerned that the US could
be headed down the path of extended stagnation that plagued Europe and Japan in
the 1990s. As this is being written, no one knows what course the US economy will
follow in the next several years and decades, but the 2001 experience has made
it clear that the ‘‘best and the brightest’’ still do not know what macroeconomic
policies to use to generate optimal performance.
In part that is because consumers and business executives react differently to the
same changes in fiscal policy at different times. Recent evidence shows that while
consumers spent 80% to 90% of the Reagan tax cuts, they spent only 20% to 25%
of the Bush tax cuts.1 Similarly, the investment tax credit spurred investment in
the early to mid 1960s and again in the late 1970s, but a 30% ‘‘bonus depreciation’’
 PREFACE AND ACKNOWLEDGMENTS xvii

adjustment in late 2001 hardly boosted capital spending at all in 2002. Results
of this sort cause most macroeconomists to take a decidedly dim view about the
short-term benefits of fiscal policy stimulus.
Because of results of this sort, very few macroeconomists still think that
models can be used for policy purposes, and this textbook does not contain
a section on that topic. Many years ago, it was widely believed that macro-
economic models could be used to improve forecast accuracy, but that concept
has also disappeared. Especially telling, in my view, has been the inability to
predict the downturns of 1991 and 2001, when the excess baggage of misleading
Keynesian nostrums had been widely discarded, and proliferation of inexpen-
sive computer time permitted exhaustive testing of a wide variety of alternative
hypotheses and models. The fact that these recessions were caused primarily
by exogenous shocks reemphasizes the degree to which unforeseen shocks are
likely to buffet the US – and the world – economies from time to time in
the future.
If macroeconomic analysis cannot be used for policy prescriptions, and it cannot
be expected to predict recessions in the future, how can a study of macroeco-
nomics benefit business managers? This text addresses the following questions
and attempts to supply relevant answers.

• What are the current economic data telling us right now? How can they best be
monitored and related to my company sales and profit outlook? To what extent
do various components of the leading indicators supply an accurate view of the
near future?
• What moves are the Federal Reserve – and the central banks in other major
countries – likely to take in the near future, and how will that affect business
conditions?
• The ratio of the Federal budget to GDP has recently changed from a 2% surplus
to a 3% deficit. How will that affect interest rates, inflation, productivity growth
– and how will changes in those variables affect my business situation?
• To what extent do international fluctuations affect my business – and to what
extent is the US economy still the ‘‘straw that stirs the drink’’? What factors
will determine whether an increasing proportion of manufacturing activity will
move to foreign locations – and where should my company be setting up new
plants?
• What linkages between interest rates and major components of consumption
and investment are most likely to hold in the future, and will enable me to gauge
the response of changes in interest rates, whether or not they are caused by the
central bank?
• The next time a recession starts, will it be short and mild, or long and severe? And
perhaps even more importantly, will the recovery be robust or stagnant? What
will that mean for monetary and fiscal policy, and how will it affect my
business?
xviii PREFACE AND ACKNOWLEDGMENTS

There are many other relevant questions that can be asked, and hopefully can
be answered, by the material found in this text. While respectfully drawing on
the theoretical developments in macroeconomics that have been made by others,
I have sought to infuse this text with a more empirical flavor and offer a valuable
guide for business managers.
Most of this material was developed when I was teaching macroeconomics at
the Kellogg Graduate School of Management at Northwestern University. In devel-
oping the course material, my perception indicated that while there were several
useful macroeconomic texts for the academic market, none of them – including my
own previous text – adequately addressed the issue of how business managers and
executives can use macroeconomic data and information to improve the perfor-
mance of their businesses. This book is the outcome of those efforts. For those who
prefer the more traditional treatment of certain key economic topics, such as con-
sumption, investment, and inflation, that material has been retained in appendixes
to some chapters. Also, the IS/LM diagram and Mundell-Fleming model are cov-
ered for optional reading; in my opinion they still offer a useful groundwork for
explaining how the economy actually works. Yet most of the exposition focuses on
how managers and executives should react to unexpected changes in key economic
variables. After all, if changes in the economy are expected, presumably there won’t
be any need to alter those business plans.

Notes
1. For a summary of these results, see ‘‘History Casts Doubt on Efficacy of Tax Cuts,’’ Wall
Street Journal, November 11, 2002, p. 2.

Acknowledgments
I would like to thank Al Bruckner at Blackwell Publishing, who originally sug-
gested this approach, and Seth Ditchik and Elizabeth Wald, who carried the project
to its fruition. Numerous students at Kellogg improved this material, but in par-
ticular I would like to thank Michael Locke and Michael Sununu for many helpful
comments. Nicholas Stadtmiller also read an early draft and offered a number of
useful comments. Finally, as always, I would like to thank Susan Carroll for stand-
ing by me in good times and bad and serving as a constant source of inspiration
and encouragement.

Michael K. Evans
Boca Raton, Florida
November, 2002