Friday, 9 August 2013

Today's figures don't add up

If you think of the world in a certain way, and someone disagrees with you, it’s natural to try to interpret their views using your mental framework.  But often the frameworks are incommensurable, and it just won’t work. The long fruitless Keynesian / monetarist debate of the 1950s is one such example.

Suppose someone told you that real business cycles models were just AS / AD [Aggregate Supply / Aggregate Demand]. Would you agree? I sure hope not, as the speaker would clearly be inferring some sort of acceptance of the AS / AD model that you see in textbooks. The one with sticky prices. And yet it would certainly be possible to explain the RBC model [Real business cycle] using the AS / AD graph, just assume a vertical AS curve.

If you assume the AS curve is always vertical then you have no business using the AS / AD model, and if you think tight money usually leads to low interest rates, then the model is basically useless. You need a different framework. Now if tight money always led to low interest rates, I suppose you could make IS [investment saving] slope upward.

Can someone tell me the difference between assuming the IS curve slopes upward, and assuming that a shift to the right in the LM [liquidity preference money] curve causes the IS curve to shift far enough to the right so that you end up with higher interest rates and higher output?

No comments:

Post a Comment