Should-Read: Nick Rowe: AD/AS: A Suggested Interpretation

Should-Read: A (mostly) smart piece by Nick Rowe. But it is not wrong to start with Knut Wicksell, as long as you get to Irving Fisher. And C+I+G+(X-M)=Y is a way of starting with Wicksell–that’s why John Hicks called it the “IS Curve”. Many might find it clearer to start with Fisher (I certainly do), but experience has taught me that that is really a matter of taste.

The rest of this, however, is excellent:

Nick Rowe: AD/AS: A Suggested Interpretation: “Many macroeconomists don’t like the Aggregate Demand/Aggregate Supply framework…. So I am going to explain it…

…You will see that it portrays a deep and realistic understanding of macroeconomics that is lost in more “sophisticated” models. If you don’t start with the AD/AS framework you are doing it wrong. The AD/AS framework is useful for thinking about monetary exchange economies…. There are two ways an individual can increase the stock of money in his pocket… he can increase the flow in; or he can decrease the flow out. But what is possible for each individual may not be possible for all individuals, because one person’s flow out is another person’s flow in. Because there are… a flow out and a flow in… two equilibrium conditions…. The economy… on the AD curve when the actual flow out equals the desired flow out [given prices, incomes, fiscal policy, and the monetary policy rule]. The economy is at a point on the AS curve when the actual flow in equals the desired flow in [given wages and the difficulties of job hunting]….

Exchange is voluntary, so that actual quantity traded is whichever is less… Y=min{Yd(on the AD curve);Ys(on the AS curve)}. And… prices are sticky, so if one of the curves shifts quickly the economy will be at a point off (at least) one of the two curves. And you might want to draw a third curve that illustrates price stickiness…. And remember that whether the economy ever actually approaches the AD/AS intersection (“full-employment equilibrium”) is an open question… and the answer to that question will depend on many things, the most important of which is the monetary system or monetary policy regime…. It is easy to imagine a monetary policy regime which makes the AD curve never cross the AS curve, or slope the wrong way….

Start… with MV=PY…. Then go on to make M and V endogenous, if you wish…. And if you don’t start with money, monetary exchange, and AD and AS, you are doing macro wrong. Because the only thing that makes macro different from micro general equilibrium theory is the fact that macro incorporates the fact of monetary exchange, which microeconomists ignore…