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 macroeconomist Chris House has 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.
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?
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.
Hence my bleg. Can anyone give a short concise definition of AD? One that I can understand. Not the definition I’d prefer (a given level of nominal spending), but rather the definition that other economists have in their heads. I mean other than House and myself, who seem to lack any clear understanding.
PS. I looked at Wikipedia, but it was no help. They suggest AD = C + I + G + NX. But that’s simply GDP. In that case doesn’t AS also equal GDP? So how is that definition useful? Surely AD means more than “GDP?”
Maybe the issue can be resolved by figuring out whether Wikipedia means real GDP or nominal GDP. Nope:
These four major parts, which can be stated in either ‘nominal’ or ‘real’ terms.
So if a student asks us if AD means RGDP or NGDP we tell them either one is fine? Even in Zimbabwe, where RGDP plunged by double digits as NGDP rose a zillion-fold? Wikipedia continues:
Sometimes, especially in textbooks, “aggregate demand” refers to an entire demand curve that looks like that in a typical Marshallian supply and demand diagram. Thus, that we could refer to an “aggregate quantity demanded” (Yd = C + Ip + G + NX in real or inflation-corrected terms) at any given aggregate average price level (such as the GDP deflator), P.
So not only is it not clear whether AD means real GDP or nominal GDP, it’s not even clear whether it means the entire demand curve or a point along the demand curve.
Now I’m even more confused. I suppose that people will tell me that it doesn’t matter because when economists like Paul Krugman talk about AD, other economists know what he is talking about. And yet I suspect Chris House and I are more the rule than the exception. Even worse, as with the stance of monetary policy, the biggest problem with AD is not that economists don’t have a consensus definition, but that they don’t even realize that they lack a consensus definition. Thus when I talk about how the Fed’s “tight money” policy caused AD to plunge in 2009, other economists aren’t able to disagree with me, because they don’t even know what I am talking about. “What tight money policy?”
When I watch from the sidelines, it seems like Paul Krugman makes his points in Portuguese, and John Cochrane responds in Norwegian. Neither understands the other, so they each assume the other side is clueless.
PPS. And didn’t Krugman once argue that the AD curve might currently be upward sloping? Now I’m really confused!