Macroeconomics

9-6

Conclusion

This chapter introduced a framework to study economic fluctuations: the model

of aggregate supply and aggregate demand. The model is built on the assump-

tion that prices are sticky in the short run and flexible in the long run. It shows

how shocks to the economy cause output to deviate temporarily from the level

implied by the classical model.

The model also highlights the role of monetary policy. On the one hand,

poor monetary policy can be a source of destabilizing shocks to the economy.

On the other hand, a well-run monetary policy can respond to shocks and sta-

bilize the economy.

5

Some economists have suggested that changes in oil prices played a major role in economic fluc-

tuations even before the 1970s. See James D. Hamilton, “Oil and the Macroeconomy Since World

War II,’’ Journal of Political Economy 91 (April 1983): 228–248.

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In the chapters that follow, we refine our understanding of this model and our

analysis of stabilization policy. Chapters 10 through 12 go beyond the quantity

equation to refine our theory of aggregate demand. Chapter 13 examines aggre-

gate supply in more detail. Chapter 14 brings these elements together in a

dynamic model of aggregate demand and aggregate supply. Chapter 15 examines

the debate over the virtues and limits of stabilization policy.