The other day Peter Dorman knocked it. Of course, Steve Keen always knocks it, but in the econ world he's not really part of 'polite society'-Richard Rorty would say that in the mainstream-Neoclassical-world, he's not considered 'an acceptable conversational partner.'
Krugman then gave AS-AD very qualified defense.
http://diaryofarepublicanhater.blogspot.com/2013/06/steve-keen-takes-on-as-ad.html
Basically, he says that it can be useful for certain models he might use but it isn't really fully AS-AD anyway.
"Now, this isn’t AS-AD for two reasons. First, the AD curve is no longer an economic relationship so much as a model of central bank behavior; a rising price level doesn’t reduce demand through its effect on the real money supply, it reduces demand through its effect on the mind of Ben Bernanke. Second, what we almost always talk about is the rate of change in prices rather than their level. (This happens not to be true when we’re worrying about issues of competitiveness within the euro area, which is why AS-AD makes something of a comeback in that discussion)."
It does help, he argues, to keep in mind that the economy-at some point-does self-correct.
"So why do AS-AD? First, you do want a quick introduction to the notion that supply shocks and demand shocks are different, that 1979-80 and 2008-2009 are different kinds of slump, and AS-AD gets you to that notion in a quick and dirty, back of the envelope way."
Krugman then gave AS-AD very qualified defense.
http://diaryofarepublicanhater.blogspot.com/2013/06/steve-keen-takes-on-as-ad.html
Basically, he says that it can be useful for certain models he might use but it isn't really fully AS-AD anyway.
"Now, this isn’t AS-AD for two reasons. First, the AD curve is no longer an economic relationship so much as a model of central bank behavior; a rising price level doesn’t reduce demand through its effect on the real money supply, it reduces demand through its effect on the mind of Ben Bernanke. Second, what we almost always talk about is the rate of change in prices rather than their level. (This happens not to be true when we’re worrying about issues of competitiveness within the euro area, which is why AS-AD makes something of a comeback in that discussion)."
It does help, he argues, to keep in mind that the economy-at some point-does self-correct.
"So why do AS-AD? First, you do want a quick introduction to the notion that supply shocks and demand shocks are different, that 1979-80 and 2008-2009 are different kinds of slump, and AS-AD gets you to that notion in a quick and dirty, back of the envelope way."
"Second — and this plays a surprisingly big role in my own pedagogical thinking — we do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run. That’s a relatively easy case to make in AS-AD; it raises all kinds of expositional problems if you replace the AD curve with a Taylor rule, which is, as I said, essentially a model of Bernanke’s mind."
"So there is a place for AS-AD, although it’s an awkward one, and the transition to IS curve plus Taylor rule plus Phillips curve, which is the model you really want to use for America right now, is a moment that fills me with dread every time we take it on in a new edition."
Of course, he's a 'pretty Keynesian guy' but not Keynesian enough for Keen and the Post Keynesian school. U.S. Keynesianism going back to Samuleson and Hicks was a merger of Keynesianism and "the Classical School'-really the Neoclassical School. The Post Keynesian school denies monetary neutrality even in the long term.
Now the Market Monetarists are on the case and they offer a full-throated defense of AS-AD:
Regarding Krugman's-less than full-throated defense-Sumner approved-but basically doesn't think he went far enough-he wants a full-throated defense, not a half-hearted one suffuse with 'dread.'
I" mostly agree, but I’d prefer to stick to AS/AD over any interest rate-oriented model. Keynesians view interest rates as the indicator of monetary policy, and also the transmission mechanism. In my view NGDP expectations are the best indicator, and the most important transmission mechanism."
Nick Rowe has a post that gets at the heart of it. There is a subtle shift with Rowe as well-Krugman likes it as a device, but Nick doesn't necessarily disagree-he says it's a great framework rather than model. So no one wants to give it a full-throated defense as a model.
"I disagree with Peter Dorman (HT Mark Thoma). I have used the AS-AD framework many times in my blog posts (and I don't remember anyone ever snickering at me for doing so) because I find it useful. Paul Krugman offers a partial defence of AS-AD, with the following caveat:
"So there is a place for AS-AD, although it’s an awkward one, and the transition to IS curve plus Taylor rule plus Phillips curve, which is the model you really want to use for America right now, is a moment that fills me with dread every time we take it on in a new edition."
"I understand that dread. I know where he's coming from. But I have decided we need to face it down. Because it's a false dread."
"I prefer to call it the AS-AD framework, rather than the AS-AD model. That's because it's a useful way of looking at many models, sometimes very different."
"Peter says that the AD curve assumes the money supply is fixed. It doesn't. Or rather, it doesn't have to. You don't need to make that assumption if you draw an AD curve. And any textbook that draws an AD curve for an open economy with fixed exchange rates certainly does not assume the money supply is fixed."
"You get one AD curve if you assume the central bank targets the money supply. You get a different AD curve if you assume it targets the exchange rate. You get a third AD curve if you assume it targets NGDP (it's a rectangular hyperbola). A fourth AD curve if you assume it targets the price level (it's horizontal). A fifth AD curve if it targets (or tries to target) real GDP (it's vertical). A sixth AD curve if it targets (tries to target) a rate of interest (it's vertical again). And so on. (And if you draw a vertical AD curve and a vertical LRAS curve you can see immediately that something is wrong, and why I said "tries to target".)"
The point for MMers like Nick is that they deny that interest rates need be the sole or main transmission mechanism. Maybe the Taylor Rule, Phillips Curve, and IS work for an interest rate targeting regime but what about one that targets NGDP-or all the countries that used to target an exchange rate?
Then he makes the case for the AS curve-which he says is probably misnamed.
"The biggest trouble with the AS curve is its name. Because only in a very limited class of models is it a supply curve. Because, strictly speaking, a "supply" curve tells you how much output firms want to sell, at any given price. If you've got sticky prices, and the economy is in recession, the economy might be on its SRAS curve, but firms will want to sell more output than they are actually selling. Even the LRAS curve isn't really a supply curve, if you have monopolistically competitive firms, because monopolistically competitive firms don't strictly have supply curves."
"We should probably just call it "the other curve". But the "AS" name has stuck. Never mind. (And the AD curve isn't strictly a demand curve either, for that matter. Because, as the Old Keynesians taught us, but younger generations of New Keynesians might have forgotten, the level of output demanded depends on income, which depends on the amount of output actually sold, which depends on the amount of output demanded. So the AD curve is really a semi-equilibrium condition, showing points at which output equals output demanded, and unlike micro demand curves it does not tell us how much output will be demanded if we are off that curve)."
"If you believe (as most of us do) that prices are flexible in the long run but sticky in the short run then you get a LRAS which is normally vertical and a SRAS which isn't vertical. But the exact shape of that SRAS depends on what particular prices are sticky, and on many other features of the model."
"Let me give one example. Suppose that in the short run all output prices are perfectly fixed. That gives you a horizontal SRAS curve. But does the SRAS curve extend to the right of the LRAS curve? That depends. If you have perfectly competitive firms that refuse to sell additional output if it's not profitable for them to do so, even if the demand is there, then the SRAS curve stops dead when it hits the LRAS curve. If you start on the LRAS curve and AD shifts right but prices are fixed, firms simply ration customers. But if you have monopolistically competitive firms the SRAS curve will continue to the right past the LRAS curve before it too eventually stops dead."
"That's a big difference. You can show that difference with AS curves. You can't show that difference with a Phillips Curve."
Lars Christensen gives us an applied use of AS-AD.
"I am somewhat surprised by Peter’s statement that the AS-AD framework is never mentioned on the econ blogs. That could indicate that Peter has never read my blog (no offense taken – I never read Peter’s blog before either). My regular readers would of course know that I am quite fund of using the AS-AD framework to illustrate my arguments. Other Market Monetarists – particularly Nick Rowe and Scott Sumner are doing the same thing quite regularly. See Nick’s discussion of Peter’s post here."
"One reason for the defense of AS-AD may be that it's vital for Market Monetarism? We go from the question is AS-AD useful to is it possible for MM to exist without it? I'd find that a fruitful discussion."
It may be this that Sumner has in mind when he criticize the use of fiscal policy for demand stabilization-the idea of him and Lars, et. al is that demand issues are nominal-and hence should be handled by the monetary authorities, fiscal policy is for "real" issues-that is long term performance.
Lars argues that the recent political unrest in Turkey over the weekend that led to a big drop in the market there is an example of a negative supply shock.
"It is obvious that the demonstrations and unrest in Istanbul are likely to lead to disruptions in production – roads are closed down, damages to infrastructure, some workers are not coming to work and even some lines of communication might be negatively impacted by the unrest. Compared to the entire Turkish economy the impact these effects is likely quite small, but it is nonetheless a negative supply shock. These shocks are, however, also likely to be temporary – short-term – rather than permanent."
"This might very well be what we will see in Turkey in the very short run – even though I believe these effects are likely to be quite small in size."
However, he thinks Dornan does have a point here:
"However, note that we here assume a “constant” AD curve.
"Peter Dorman is rightly critical about this assumption in his blog post:
“…try the AD assumption that, even as the price level and real output in the economy go up or down, the money supply remains fixed.”
"Peter is of course right that the implicit assumption is that the money supply (or money base) is constant. The standard IS/LM model suffers from the same problem. A fact that have led me to suggest an alternative ISLM model – the so-called IS/LM+ model in which the central bank’s monetary policy rule is taken into account."
Indeed, Lar's IS/LM is a good example of using the AS-AD 'framework' a lot.
Even if the political unrest of Turkey is just a short-term negative supply shock, it can lead to a long term drop in real growth. An example of this could be the EU raising interest rates because they wrongly saw the commodity based supply side spike as an inflationary threat and raised interest rates.
"Hence, regime uncertainty therefore is likely to reduce the long-run growth in the Turkish economy. Obviously it is hard to estimate the scale such effects, but at least judging from the sharp drop in the Turkish stock market today the negative long-run supply shock is sizable."
He thinks it can also have an effect on the demand side if higher-supply side inflation-leads the Turkish Central Bank to tighten.
Lars finally argues that the "tourism multiplier is zero' any drop in demand due to lower tourism because of the unrest will be made up for by the Central Bank. Lars argues therefore that this is an example of using the AS-AD model in action.
He agrees it has its limitations and that a DSGE model could have done the same analysis of Turkey. However, it would have probably been very hard to read with all the dense mathematical equations.
"I hope that my discussion above have demonstrated that the AS-AD framework can be a very useful tool when analyzing real world problems – such as the present public unrest in Turkey. Obviously Peter Dorman is right – we should know the limitations of the AS-AD model and we should particularly be aware what kind of monetary policy reaction there will be to different shocks. But if we take that into account I believe the textbook (the Cowen-Tabarrok textbook) version of the AS-AD model is a quite useful tool. In fact it is a tool that I use every single day both when I produce research in my day-job or talk to clients about such ‘events’ as the Turkish demonstrations."
"Furthermore, I would add that I could have done the same kind of analysis in a DSGE framework, but I doubt that my readers would have enjoyed looking at a lot of equations and a DSGE model would likely have reveal little more about the real world than the version of the AS-AD model I have presented above."
Enough to chew on for now. However, hopefully some more back and forth on the AS-AD soon as I find it very interesting. Again, I note that no Market Monetarist doesn't seem to see a use for it-is it more than a use but a need?
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