Anticipating Government Policy

Now let's put these ideas to work. Suppose that the government adopts a policy designed to expand aggregate demand. Specifically, suppose that the government regards the NAIRU as too high. Thus, the government adopts expansionary macroeconomic policies designed to expand production beyond the NAIRGDP. It doesn't matter whether these are fiscal or monetary policies or some combination of the two.

Here's a familiar picture of the short-run result.

Figure 4: Expansionary Fiscal Policy in the Short Run

As we recall from the previous chapter, the price level is a little higher than expected, at p₂, and because this comes as a surprise, production is to the right of the NAIRGDP, at Y. But in the long run, the SAS will shift in such a way that production moves back to the NAIRGDP, as shown by Figure 5.

Figure 5: Expansionary Fiscal Policy in the Long Run

To keep production at Y, the government would have to adopt new, even more expansionary policies, shifting the AD curve to the right, beyond AD₂, faster and faster to offset the faster and faster backward shifting of the SAS curve.

But even that would be ineffective. People would see a series of price-and-production observations like Figure 2 and would begin to take into account the government's pattern of increasingly expansionary policies, and anticipate them, and shift their short-run supply curves backward even faster, so that production would return to the NAIRGDP despite the increasingly expansionary government policies.

Policy Ineffectiveness