The tasks of macroeconomics are to interpret observations on economic aggregates in terms of the motivations and constraints of economic agents and to predict the consequences of alternative hypothetical ways of administering government economic policy. General equilibrium models form a convenient context for analyzing such alternative government policies. In the past ten years, the strengths of general equilibrium models and the corresponding deficiencies of Keynesian and monetarist models of the 1960s have induced macroeconomists to begin applying general equilibrium models.

This book describes some general equilibrium models that are dynamic, that have been built to help interpret time-series of observations of economic aggregates and to predict the consequences of alternative government interventions. The first part of the book describes dynamic programming, search theory, and real dynamic capital pricing models. Among the applications are stochastic optimal growth models, matching models, arbitrage pricing theories, and theories of interest rates, stock prices, and options. The remaining parts of the book are devoted to issues in monetary theory; currency-in-utility-function models, cash-in-advance models, Townsend turnpike models, and overlapping generations models are all used to study a set of common issues. By putting these models to work on concrete problems in exercises offered throughout the text, Sargent provides insights into the strengths and weaknesses of these models of money. An appendix on functional analysis shows the unity that underlies the mathematics used in disparate areas of rational expectations economics.

This book on dynamic equilibrium macroeconomics is suitable for graduate-level courses; a companion book, Exercises in Dynamic Macroeconomic Theory, provides answers to the exercises and is also available from Harvard University Press.

Describes and illustrates several dynamic general equilibrium models and applies them to problems in macroeconomics and monetary economics...Introduces discounted dynamic programming, the theory of search, and asset prices and consumption. Then focuses on monetary economics and government finance. Introduces currency in the utility function model and considers and uses cash-in-advance models as well as models that relate to credit and currency with long-lived agents and with overlapping generations. The last chapter discusses government finance in stochastic overlapping generations models. Each chapter contains exercises and suggested readings.

A new book by Sargent is an important event for macroeconomists. His Macroeconomic Theory...has influenced teaching and research in graduate schools for nearly a decade. His new book, quite different from the first one, is likely to have as much influence. It is an important book...well-written and well-organized, and each chapter is followed by exercises, some of which apply the chapter's models and advance them in new directions...The approach to macroeconomics taken by Sargent in this book is relatively new, and most of the fundamental questions of macro are still unsettled...The approach advocated by Sargent...gives hope that answers to these questions may be possible.

book, Exercises in "Dynamic Macroeconomic Theory," provides answers to the exercises and is also available from Harvard University Press.

Introduction

References and Suggested Readings

PART I REAL DYNAMIC MACROECONOMIC MODELS

1. Dynamic Programming

A General Intertemporal Problem

A Recursive Problem

Bellman's Equations

Nonstochastic Examples

The Optimal Linear Regulator Problem

Stochastic Control Problems

Examples of Stochastic Control Problems

The Stochastic Linear Optimal Regulator Problem

Dynamic Programming and Lucas's Critique

Dynamic Games and the Time Inconsistency Phenomenon

Conclusions

Exercises

References and Suggested Readings

2. Search

Nonnegative Random Variables

Stigler's Model of Search

Sequential Search for the Lowest Price

Mean-Preserving Spreads

Increases in Risk and the Reservation Price

Intertemporal Job Search

Waiting Times

Firing

Jovanovic's Matching Model

Conclusions

Exercises

References and Suggested Readings

3. Asset Prices and Consumption

Hall's Random Walk Theory of Consumption

The Random Walk Theory of Stock Prices

Lucas's Model of Asset Prices

Mehra and Prescott's Finite-State Version of Lucas's Model

Asset Pricing More Generally

The Modigliani-Miller Theorem

Government Debt and the Ricardian Proposition

Remarks on Testing and Estimation

Conclusions

Exercises

References and Suggested Readings

PART II MONETARY ECONOMICS AND GOVERNMENT FINANCE

4. Currency in the Utility Function

The Price of Inconvertible Government Currency in Lucas's Tree Model

Issues and Models in Monetary Economics

Government Debt in the Utility Function

Government Currency in the Utility Function

Seignorage and the Optimum Quantity of Currency

A Neutrality Proposition

Conclusions

References and Suggested Readings

5. Cash-in-Advance Models

A One-Country Model

Fisher Equations

Inflation-Indexed Government Debt

Interactions of Monetary and Fiscal Policies

Interest on Reserves

A Two-Country Model

Exchange Rate Indeterminacy

Conclusions

Exercises

References and Suggested Readings

6. Credit and Currency with Long-Lived Agents

The Physical Setup

Optimal Allocations

Competitive Equilibrium

A Digression on the Balances of Trade and Payments

The Ricardian Doctrine about Taxes and Government Debt

The Model with Valued Currency and No Private Debt

An Interventionist Optimal Monetary Equilibrium

Townsend's "Turnpike" Interpretation

Conclusions

Exercises

References and Suggested Readings

7. Credit and Currency with Overlapping Generations

The Overlapping-Generations Model

The Ricardian Doctrine about Taxes and Government Debt Again

A Ricardian Proposition

Currency, Bonds, and Open-Market Operations

Computing Equilibria

Interpretations as Currency Equilibria

Optimality

Four Examples on Inflation and Its Causes

Seignorage and the Laffer Curve

Dynamics of Seignorage

Forced Saving

International Exchange Rates

Conclusions

Exercises

References and Suggested Readings

8. Government Finance in Stochastic Overlapping-Generations Models

The Economy

Some Examples

A General Irrelevance Theorem

Wallace's Modigliani-Miller Theorem for Open-Market Operations

Chamley and Polemarchakis's Neutrality Theorem

Interpretation as a Constant Fiscal Policy

Indexed Government Bonds

A Ricardian Proposition

Further Irrelevance Theorems

Conclusions

Exercises

References and Suggested Readings

Appendix. Functional Analysis for Macroeconomics

Metric Spaces and Operators

First-Order Linear Difference Equations

A Formula of Hansen and Sargent

A Quadratic Optimization Problem in R

A Discounted Quadratic Optimization Problem

Predicting a Geometric Distributed Lead of a Stochastic Process

Discounted Dynamic Programming

A Search Problem

Exercises

References and Suggested Readings

Index