Three Propositions
Of course, there is a limit to how far this can be carried. There is a limit to how much can be produced with a given population, technology, and natural resources, and policies that push aggregate demand beyond that limit will cause unpleasant surprises. That will be the upper limit beyond which even a path-dependent Aggregate Supply relation cannot be pushed. I doubt that any economist would question that. As the New Classical economists have argued, the upper limit probably is not absolute. Quite likely we can push production beyond it in the short run, either because it comes by surprise or for other reasons. But production will not be persistent, and in fact will not be sustainable, beyond that limit. In the example given here, we have spoken of expansionary aggregate demand policy to restore production to an earlier LAS, because it seems very likely that the earlier level is within the upper limit. After all, if the economy has produced that amount before, over a long period of time, it seems likely that it can do so again.
Just as there are New Classical economists, working to reformulate the traditional "classical" ideas in macroeconomics, so there are "New Keynesians" working to reformulate the Keynesian ideas. In fact, there are several flavors of New Keynesians. Here is the way that some New Keynesians would interpret all this:
It seems that there is a range of RGDP numbers, any one of which might be the NAIRGDP, depending on the recent history of production. Within that limit, production is highly persistent, Aggregate Supply is path dependent, and Aggregate Demand policy may be effective, depending on details. These things are generally not so outside the range. The maximum sustainable production with available resources defines the upper limit of the range, but the lower limit is indefinite. Indeed, since production may be temporarily pushed beyond the sustainable upper limit, the upper limit is not very definite either. It surely is there, but one of the great puzzles of modern macroeconomic policy is to determine just how far the policy can be pushed before it breaks down in inflation. Some economists believe the economic authorities in the United States and some other industrialized countries, especially the directors of the Fed and the other central banks, have consistently underestimated that upper limit and have contributed to the stagnation of the industrial countries by restraining Aggregate Demand too much.
Three Propositions
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