Abstract

PALLEY, Thomas I.. The Macroeconomics of Aggregate Demand and the Price Level. Inv. Econ [online]. 2008, vol.67, n.263, pp.49-65. ISSN 0185-1667.

The effect of prices on aggregate demand (AD) is one of the most important questions in macroeconomics. The conventional assumption is that a lower price level increases ad. However, there are good reasons to believe the opposite. The monetary base on which the Pigou effect operates is small; the interest rate channel may be weak, or even blocked entirely; and Fisher debt effects are likely strong in modern financial economies with extensive credit. Moreover, increased debt burdens can unleash bankruptcy effects that destroy the banking system. This suggests Keynes was right about the price system's inability to solve deficient demand unemployment. This conclusion has enormous implications for both teaching of macroeconomics and economic policy.

Keywords : prices; aggregate demand; interest rate; debt; credit; unemployment.

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