Brief History of Macroeconomic Thought and Policy

Answer To Try It Problem

Even with an inflationary gap, it is possible to pursue expansionary fiscal and monetary policies, shifting the aggregate demand curve to the right, as shown. The inflationary gap will, however, produce an increase in nominal wages, reducing short-run aggregate supply over time. In the case shown here, real GDP rises at first, then falls back to potential output with the reduction in short-run aggregate supply.