[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Finally, although we have emphasized the role of the central bank’s policy rule
in producing the negative slope of the ADI curve, other factors are also at work.
When the rise in prices outpaces the growth in money, the real value of money held
by households and businesses is reduced. This reduction in real wealth may cause
consumption and investment spending to decline. When prices rise more rapidly
than nominal wages, real wages fall and this may cause consumption and spending
to decline. In an open economy, more rapidly rising prices will, for a given
exchange rate, increase the prices of domestically produced goods relative to
foreign-produced goods. As a result, demand will shift away from domestic
goods and toward foreign goods, reducing the overall demand for domestic output.
These factors, like the monetary policy response we have emphasized, contribute
to the negative relationship between inflation and GDP that is captured by the
ADI curve.
To summarize, the negative relationship between inflation and short-run
equilibrium GDP represented by the ADI curve is based on the following set of
linkages:
Increases in
inflation
Increases in real interest
rate
Decreases in
aggregate spending
Wrap-Up
THE AGGREGATE DEMAND–INFLATION (ADI)
CURVE
The ADI curve shows, for each value of inflation, the economy’s short-run equilibrium
level of output. Higher rates of inflation are associated with higher real
interest rates, lower aggregate expenditures, and lower equilibrium output.
The central bank’s monetary policy rule—the way monetary policy reacts
to inflation—and the sensitivity of aggregate spending to the real interest are
important in determining the negative slope of the ADI curve.
WHAT CAN SHIFT THE ADI CURVE?
Just as it is important to understand why the ADI curve has a negative slope, so too
we need to understand the factors that can cause the curve to shift. For a given monetary
policy rule, an ADI curve shows the equilibrium level of GDP for each rate of
inflation. Movements in aggregate demand and GDP caused by changes in inflation
translate into movements along a given ADI curve. Changes in any other factor that,
for a given inflation rate, affect aggregate demand will shift the curve. Two of the
most important examples of factors that can cause such a shift are fiscal policy and
changes in the central bank’s policy rule.
694 ∂ CHAPTER 31 AGGREGATE DEMAND AND INFLATION