Olivier Blanchard is criticizing the Aggregate Supply-Aggregate Demand model…
“Turning to the supply side, the contraption known as the aggregate demand–aggregate supply model should be eliminated.” (link)
Let me show you something good… I am the only one in the world using this model of Effective Demand with Aggregate Supply…
What you are looking at is all of the effective demand limit curves from 4th quarter 2008 to 4th quarter 2014. That is 6 years of quarterly data. The crisis started at the end of 2008.
Notice how all of the curves point to a zone at a core inflation target zone of 2%. All of the curves fall into a zone from $15.9 to $16.2 trillion (real 2009 $$) at that core inflation target zone.
When real GDP reached $16.1 trillion in the last half of 2014, hitting the heart of that zone marked in the graph, corporate profits peaked and other factors peaked. The effective demand limit curves began to balloon upward. The business cycle peaked. This AS-ED model had seen it coming for 6 years. That is what the AS-AD model could do, if it incorporated effective demand.
Here is what happened when real GDP hit the zone… You can see the effective demand limit curves starting to move out toward a new zone for the next business cycle. That is how it works.
Think about it… The top of the business cycle was seen developing as far as 6 years in advance by this model!
Olivier Blanchard can eliminate the AS-AD model, but nobody touches my AS-ED model… This model is golden.
Update: The 2nd graph above does not mean that inflation is going up to 8%. The red dots show where the AS and ED curves cross. Those crossing points fall toward the natural limit zone as the AS curves move right in the 1% to 2% inflation horizontal. As real GDP goes by the natural limit, the crossing points move start to move upward like bouncing on the limit zone. Real GDP still moves below near 2% core inflation.
Look at the black horizontal arrow in the 2nd graph that says… “track of real GDP”… that is real GDP moving along near 2%… but the ED limit curve crosses the projected future path of real GDP shown by the black arrow. That crossing point shows us where real GDP will encounter its natural limit.
Update: Effective Demand limit curves use the same equation as in this model for the Effective Consumption Demand curve…