Continuing from this post, I decided to look at what the Aggregate Demand (AD = NGNP) and Aggregate Supply (AS = MB) curves look like in these next two posts. Basically, I looked at a fixed point on the surface for a given year and looked at the curves at fixed AD (a demand curve) and fixed AS (a supply curve). I also showed what the curves looked like for a 5% boost in AD and AS from the fixed point. The former are shown as solid red (supply) and blue (demand) lines, the latter (boosted) are shown as dashed versions. Here is the graph for 2012:

And here is what the curves look like from 1940-2010 by decade:
Note the weird parallel curves in 2000 (it persists over most of the early 2000s until the financial crisis). Speculation: does this have anything to do with the strange flattening out of the monetary base growth in the 2000s? Did the economy become unresponsive to changes in the monetary base (and NGDP) and lead the Fed to think its tight money policy was appropriate? Would a slowly tightening policy ~~would~~ go unnoticed in the aggregate data? I don't know the answer to these questions. I don't even know if this model should actually be able to suggest them! In the next post, I show the series as we go through the financial crisis.

Yes, the AD and AS curves appear to be tilted in a strange direction in the 2012 graph (actually this is true ever since the Great Recession started). Prior to the 2000s, the curves look more like typical supply and demand curves.

ReplyDeleteAnother point on "the price level" vs "the value of money". I've done everything in terms of the price level (i.e the GDP deflator, CPI and analogs). If you were to look at the graph above for, say, 1960 you might see that a 5% increase in the monetary base leads to a reduction of the price level. Isn't printing money supposed to decrease the value of a dollar and lead to inflation?

ReplyDeleteBut check the scale on the vertical axes. I set them up all to be approximately 10% windows. You can see that the 5% increase in the (nominal) monetary base leads to a ~1% decrease in the price level and a 1% increase in the (equilibrium) nominal GDP. These roughly offset (at least in the 1960 graph), so that the RGDP is unchanged. With a 5% larger monetary base, each dollar buys ~5% less of the real economy. Therefore the real value of a dollar has in fact fallen.

Sign error. The 1% decrease in the price level is not offset by the 1% increase in NGDP, they add ... resulting in a 2% increase in RGDP, which is still less than the 5% increase in the base so the real value of the dollar has still fallen (by about 3%).

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