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

expected inflation rate equal to π 0 . In the situation depicted, the shortrun
equilibrium occurs at point E 1 with output equal to Y 1 and inflation
equal to π 1 . Two aspects of this short-run equilibrium are important
to note. First, the economy is producing at an output level above potential
(Y f ). Second, the inflation rate π 1 is greater than people had
expected.
The economy will not remain at point E 1 , however, because inflation
is now higher than people had expected. Inflation expectations
will rise. As we learned in this chapter, a rise in inflation expectations
causes the SRIA curve to shift up. As the SRIA curve shifts
up, the economy’s equilibrium moves along the ADI curve (shown
by the arrow). Inflation continues to rise and output falls. This
movement along the ADI curve involves rising interest rates. As
inflation expectations rise, so does actual inflation. In response to
rising inflation, the Fed raises interest rates and aggregate expenditures
fall. Equilibrium output declines toward the full-employment
level. Eventually, full-employment output is reached at an
inflation rate of π 2 . At this point, equilibrium output is equal to Y f
(so the economy is on its ADI curve) and both actual inflation and
expected inflation are equal to π 2 .
INFLATION (π)
π 2
π 1
π 0
Figure 37.8
Aggregate
demandinflation
curve
Expected
inflation = π 2
Expected
E 1
Y f Y 1
OUTPUT (Y )
Short-run
inflation
adjustment
curves
inflation = π 0
COMBINING THE ADI AND SRIA CURVES
The economy’s short-run equilibrium is at the point where
the ADI and SRIA curves intersect: E 1 , in this figure. At E 1
output is above potential and inflation exceeds expected
inflation. As people revise upward their expectations of
inflation, the SRIA curve shifts up. Eventually, output
returns to Y f at an inflation rate equal to π 2 . At that point,
output is equal to potential and inflation is equal to
expected inflation.
COMBINING THE AGGREGATE DEMAND–INFLATION AND INFLATION ADJUSTMENT CURVES ∂ 833