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Whatcausesarecession assumewestartaty0 inlrequilibrium

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Unformatted text preview: d Growth LRAS and Growth Vertical need not mean fixed LRAS can shift right – – – P Population Capital stock Technology Real GDP rises Prices fall – Good deflation – AD can also shift right LRAS LRAS P0 P1 AD y0 y1 y Short Run Aggregate Supply Short Run Aggregate Supply “Sticky “ wages and prices – Contracts – Menu costs P AS AS slopes up – Price rises – Value of labor rises – If w fixed then L rises – y rises as a result y What Causes a Recession? What Causes a Recession? Assume we start at y0 – In LR equilibrium – Investment falls P LRAS What happens to AD? y0 y The Onset of a Recession The Onset of a Recession AD shifts right – Also happens if C, G, or NX falls GDP falls P AD LRAS AD’ AS – y1 < yfe Prices fall as well y1 yfe=y0 y What Cures a Recession? What Cures a Recession? GDP falls – Fewer workers hired Unemployment rises P LRAS AD AS AD’ AS’ – Wages fall AS shifts out – Firms hire more – yfe restored y1 y0 y Why Bother Intervening? Why Bother Intervening? The adjustment process may be slow – We may have y < yfe for a long time “In the long run, we’re all dead” Did Obama’s Stimulus “Fail”? Did Obama’s Stimulus “Fail”? What is “failure”? – Unemployment has only recently fallen below 8% – Congress is unwilling to spend more The problem was bad numbers – In early 2009, things looked very bad BEA estimated that GDP fell at an annual rate of 3.8% in 2008.IV Designed massive stimulus in response – It turns out things were even worse Revised figures show GDP shrank 8.9% in 2008.IV Massive wasn’t massive enough Perceived Problem Perceived Problem LRAS P AD AS y Investment Collapses & GDP Investment Collapses & GDP Falls LRAS AD P AS AD’ Q Increasing G Should Restore Increasing G Should Restore GDP LRAS AD P AS AD’ Q But the Drop Was Much Greater But the Drop Was Much Greater LRAS AD P AS AD’ Q The Response Was Inadequate The Response Was Inadequate LRAS P AD AS AD’ Q The Result The Result The economy avoided Armageddon Things were still bad People are now calling for spending cuts What will that do?...
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