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

offsetting amount. But the contractionary impact of monetary policy
more than offset the expansionary effect of lower taxes, and the ADI
curve shifted to the left, as shown in Figure 31.5.
Figure 31.6 shows the results of this shift in monetary policy. Output
declined below potential GDP and the unemployment rate briefly
hit a post–World War II high of 11 percent. However, the recession
did succeed in curbing inflation, which dropped from around 9 percent
in 1980 to just 3.2 percent in 1983. 2 As the economy moved to its
new equilibrium at point E 2 in Figure 31.5, unemployment fell; by 1985,
the economy was essentially back at full employment.
INFLATION (π)
E 2
π 1
IA 1
E 0
E 1
π 0 IA 0
ADI 1
ADI 0
Y f Y 1
An Expansionary Shift in the
ADI Curve
Figure 31.7
Figure 31.7 illustrates a different scenario, one in which the ADI curve
has shifted to the right. This type of shift is caused by a positive shock
to spending; perhaps firms have become more optimistic about the
future and have increased investment spending on plant and equipment.
Or perhaps the government has increased its purchases or cut
taxes. In response to the growth in demand, firms expand production.
They hire more workers, average weekly hours rise as workers work
more, and unemployment falls. Firms utilize their plant and equipment
more intensively, perhaps adding extra shifts or delaying maintenance in order
to keep production lines running at top speed. These adjustments enable output to
rise above levels associated with normal conditions. Output rises above Y f , moving
the economy to E 1 ; the new equilibrium level of output is now Y 1 .
Just like a recession caused by a drop in spending, the boom caused by increased
spending does not last forever. To attract and retain workers, firms are willing to
increase wages more rapidly, and they can push up prices with less fear of losing
markets. As inflation rises, the Fed boosts interest rates. As it does so, the economy’s
equilibrium level of output will tend to fall back toward the full-employment
level. The economy moves up the ADI curve from point E 1 toward point E 2 in Figure
31.7. Eventually, output will return to Y f at point E 2 with a higher rate of inflation.
OUTPUT (Y )
A BOOM CAUSED BY A SHIFT IN
AGGREGATE DEMAND
If the aggregate demand curve shifts to the right (from
ADI 0 to ADI 1 ), firms will increase production. Output and
employment rise, and the new short-run equilibrium level
of output is Y 1 . Eventually, wages and prices will start
rising more rapidly and the economy will move up the
aggregate demand–inflation curve toward the fullemployment
equilibrium at point E 2 , where output has
returned to Y f but inflation is now higher at π 1 .
Case in Point
THE KENNEDY TAX CUT
In 1963, the unemployment rate in the United States seemed to be stuck at an unacceptably
high level, 5.5 percent. Ten years earlier it had been 2.8 percent. President
2 The peak rate of inflation was even higher if measured by the consumer price index (CPI), reaching 13
percent in 1980.
AN EXPANSIONARY SHIFT IN THE ADI CURVE ∂ 701