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Sunday, June 02, 2013

The Aggregate Supply—Aggregate Demand Model in the Econ Blogosphere

Peter Dorman would like to know if he's wrong:

Why You Don’t See the Aggregate Supply—Aggregate Demand Model in the Econ Blogosphere: Introductory textbooks are supposed to give you simplified versions of the models that professionals use in their own work. The blogosphere is a realm where people from a range of backgrounds discuss current issues often using simplified concepts so everyone can be on the same page.
But while the dominant framework used in introductory macro textbooks is aggregate supply—aggregate demand (AS-AD), it is almost never mentioned in the econ blogs. My guess is that anyone who tried to make an argument about current macropolicy using an AS-AD diagram would just invite snickers. This is not true on the micro side, where it’s perfectly normal to make an argument with a standard issue, partial equilibrium supply and demand diagram. What’s going on here?
I’ve been writing the part of my textbook where I describe what happened in macro during the period from the mid 70s to the mid 00s, and part of the story is the rise of textbook AS-AD. Here’s the line I take:
The dominant macro model, now crystallized in DSGE, is much too complex for intro students. It is based on intertemporal optimization and general equilibrium theory. There is no possible way to explain it to students in their first exposure to economics. But the mainstream has rejected the old income-expenditure models that graced intro texts in the 1970s and were, in skeleton form, the basis for the forecasting models used back in those days. So what to do?
The solution has been to use AS-AD as a placeholder. It allows instructors to talk about both prices and quantities in a rough market context. By putting Y on one axis and P on another, you can locate any macroeconomic outcome in the upper-right quadrant. It gets students “thinking like economists”.
Unfortunately the model is unsound. If you dig into it you find contradictions that can’t be papered over. One example is that the AS curve depends on the idea that input prices for firms systematically lag output prices, but do you really want to argue the theoretical and empirical case for this? Or 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.
That’s why AS-AD is simply a placeholder. It has no intrinsic value as an economic model. No one uses it for policy purposes. It can’t be found in the econ blogs. It’s not a stripped down version of DSGE. Its only role is to occupy student brain cells until the real work of macroeconomic instruction can begin in a more advanced course.
If I’m wrong I’d like to know before I cut off all lines of retreat.

This won't fully answer the question (many DSGE adherents deny the existence of something called an AD curve), but here are a few counterexamples. One from today (here), and two from the past (via Tim Duy here and here).

Update: Paul Krugman comments here.

    Posted by on Sunday, June 2, 2013 at 12:15 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (53)

          


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