Scott Sumner on AS-AD

A good post. Read the whole thing. He ends up,

I’d like to dispense with all discussion of AS and AD, and replace it with nominal shocks and real shocks. A nominal shock is an unexpected change in NGDP. A real shock changes the price/output split for any given level of NGDP. As Tyler suggests, one type of shock is often entangled with the other. But it’s still important to keep them clear as a theoretical matter, so that we can think clearly about how monetary policy should respond (or not respond) to various types of situations.

PSST is all about real shocks. I am inclined to think of money and inflation as “consensual hallucinations.” That is, people get into habitual ways of undertaking transactions and adjusting prices. In the 1970s, these habits changed quite a bit. In other periods, they have been more stable. Often, the “noise” in prices (problems with measuring the “aggregate price level”) is large relative to any signal that might be inferred from changes in the measured rate of inflation. So I think that attempts to explain inflation on the basis of alleged causal variables, whether monetary or real (e.g., the unemployment rate) involve torturing the data to obtain a confession.

3 thoughts on “Scott Sumner on AS-AD

  1. Money and price levels may be consensual hallucinations, but long term debt freezes those hallucinations in place long after habits and patterns change. Would a PSST perspective teach us to discourage long term nominal instruments?

  2. Mr. Kling, from the initial pages of your PSST paper (which i haven’t read entirely yet), I would say there are similarities with your thinking and the Austrian School of Economics. Is this a wrong assesment ? Thanks.

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