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Some graphs to accompany the
dynamic analysis of the closed economy
AD-AS model. Ch 19 and 20 in IAM.
RNy
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Inflation
AD
With high b
With high b, π need not fall so much in order to
increase the real interest rate.
AD
With low b
y
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Inflation
AD
With low h
With low h, an increase in π leads to only a small
increase in the real interest rate. Therefore a
small reduction in y
AD
With high h
y
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Inflation
SRAS
Position in t=0
πo
AD
Position in
t=0
yo
The short-run equilibrium
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y
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Inflation
LRAS
Π*
AD
y-
The long-run equilibrium
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y
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SRAS
Position in t=0
Inflation
π
o
Π*
AD
Position in
t=0
yo
Y_
Dynamic adjustment from initial
situation to long-run equilibirum (no
shocks during the process)
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y
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Inflation
SRAS, t=2
LRAS
SRAS, t=0, t=1.
C
πo=π*
B
A
AD, t=1
AD, t=0, t=2, t=3……….
Yo=y_
The response to a temporary demand
shock
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y
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Inflation
LRAS
SRAS, t=2
SRAS, t=0, t=1
C
B
πo=π*
A
AD, t=1,
AD, t=0,
Yo=y_
y
The response to a permanent temporary demand shock.
Without the i-target, the new equilibrium would be at C.
However, the real interst rate increased.
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Inflation
AD ( b >0)
With b=0 there is no interest rate reduction
initially.
B
A
b > 0 reduces the effect on both output
and inflation. Policy is countercyclical.
B
AD, b=0
y
Effects of negative demand shock. h>0 in both AD curves.
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AD ( b >0)
and h low
Inflation
B
With b=0 there is no interest rate reduction
initially.
B
A
b > 0 reduces the effect on both output
and inflation. Policy is countercyclical.
AD, b=0
and h high
y
Effects of negative supply shock: A trade-off between
inflation and y stabilization.
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