Awhile ago I debated with utilitymaximiser (now ordnungsokonomik) about the concept of aggregate demand. I said it was coherent, and there was no good explanation of what it was, why there was an inverse relationship with the price level, and that it should pretty much be ignored.
Scott Sumner is now admitting that he doesn’t have a definition for aggregate demand:
What does “aggregate demand” mean?
And why am I asking this question after using the phrase about 1000 times over the past 5 years in this blog? Shouldn’t I have found out before I started using the term? Perhaps I was too embarrassed to admit my ignorance. But now that the esteemed macroeconomistChris Househas admitted a similar uncertainty, I’m less embarrassed:
… I admit that I don’t have a particularly clear definition of what we really mean by “aggregate demand.” I think often this is meant to capture changes in consumer sentiment, fluctuations in government demand for goods and services or other incentives to purchase market goods – incentives which would include tax subsidies, monetary stimulus, … etc.
But Sumner has a definition of what AD should mean:
I do have a very clear idea as to what I think the profession should mean by AD—nominal GDP. And I’ve seen the AD curve drawn as a rectangular hyperbola in a few textbooks (although the number is gradually diminishing. But it’s clear that most people don’t agree with me. So what do they think AD is?
A rectangular hyperbola looks like this:
Note: this is for a regular demand curve, not an aggregate demand curve, but it looks the same.
This post gets even better!
On some occasions people discuss AD as if it’s a real concept. Changes in the real quantity of goods and services purchased by consumers, investors, governments, and (in net terms) foreigners. But that can’t be AD, as it would imply that all changes in RGDP were caused by shifts in AD. After all, all purchases are also sales, so the total aggregate quantity supplied equals the total aggregate quantity demanded
In the textbooks AD is a downward sloping line in P/Y space, which is not generally assumed to be unit elastic. That means when AS shifts, NGDP may also change. But why does NGDP change? What is held constant along a given AD curve? Presumably a given AD curve is supposed to be holding constant things like monetary and fiscal policy, animal spirits, consumer sentiment, etc.
But that raises another question; what is monetary policy? If the profession is not too clear about AD, they are completely mixed up about monetary policy. Indeed even elite macroeconomists have such wildly varying definitions of monetary policy that in any given monetary situation (such as the early 1930s—with ultra-low interest rates and lots of QE), one set of respected macroeconomists will claim policy is ultra-tight (Friedman, Bernanke, Mishkin, etc) while another (even larger) set of economists will claim policy is ultra-accommodative (because interest rates were really low and there was lots of QE.) So it doesn’t much help to say we are holding monetary policy constant along an AD curve, as no one seems to have a clue as to what the term ‘monetary policy’ actually means.
So it would seem the issues with AD aren’t just about “what it is” but also “what affects it” - not to mention the fact that macroeconomists don’t have a lot of consensus on the nature of monetary policy.
PS. I looked at Wikipedia, but it was no help.
Sumner goes on to savage the Wiki entry for AD.
Sumner has two other posts about aggregate demand, one concerning IS/LM and the other breaking apart the logic of aggregate demand.
Thankfully, I am not the only person who generally agrees with the idea of “demand side” problems concerning recessions, as well as the effect of money on nominal spending but also has issues with aggregate demand. As a friend of mine commented on how AD is taught at our university, many people teach it as “demand, but jumbo.”
In the article concerning IS/LM, Sumner writes out a model for AD/AS:
Here’s a simpler model. AD is a hyperbola (a given level of NGDP). This model does not assume NGDP targeting, just as the current AD model does not assume money supply targeting. Changes in NGDP are caused by monetary policy. The P/Y split for changes in NGDP is determined by the slopes of the SRAS and LRAS curves. The LRAS curve is vertical. Interest rates? Yeah, they fluctuate a lot.
I quite like this - it gives a fairly conventional view of “demand side” fluctuations without the really bad Y=C+I+G+NX and somehow saying that slopes downward because of Pigou Effects (when even Paul Krugman argues that Pigou Effects don’t exist in real life).