Suppose the economy is at point 1 in Figure 13.1. With output below potential output, it might not be possible to create any expectation of an increase in inflation
How, then, might output be brought back to potential? What would this look like on the graph?
The reason output is so low is that the real interest rate at which the goods market is in equilibrium is negative. If expected inflation were high enough, the real interest rate could be low enough. An alternative to raising expected inflation is to persuade businesses and consumers to increase spending at every level of the real interest rate — that is, shift the IS curve to the right. An increase in autonomous spending, and/or a decrease in financial frictions both shifts AD to the right, and removes the kink, restoring the usual negative relationship between output and inflation. Nonconventional monetary policy can provide such a positive demand shock, increasing both output and the long-run equilibrium real interest rate. On the graph, the new aggregate demand curve might intersect the LRAS curve at an inflation rate somewhat lower than .
You might also like to view...
If a firm in a perfectly competitive industry introduces a lower-cost way of producing an existing product, the firm will be able to earn economic profits in the long run
Indicate whether the statement is true or false
If a public service commission requires a natural monopoly to set its price equal to the long-run marginal cost, this will result in
A) excessive economic profits to the monopoly. B) normal economic profits to the monopoly. C) losses to the monopoly. D) either economic profits or losses, depending on the efficiency of the monopoly.