June 28, 2019

The Dynamic AS/AD model is a good guide to understanding the economy over the last 25 years of low & stable inflation

Two charts help to set the stage. To better understand them, the AD curve should be viewed as a rectangular hyperbola. That means that the elasticity along the curve is unity. In that case, along the curve, NGDP growth is constant, say 5%. In other words, a fall in real growth is exactly offset by a rise in inflation. It also means, from a monetary policy perspective, that velocity (or money demand) changes are exactly offset by changes in money supply. In Chart 1, I illustrate the case of a (negative) demand shock. In that case, NGDP growth falls (to… Read More