LECTURE 11: SHORT-RUN ECONOMIC FLUCTUATIONS: AGGREGATE DEMAND AND AGGREGATE SUPPLY

1. Causes of short-run fluctuations in economic activity.

2. What can public policy do to avoid recessions?
3. How can policy-makers reduce their lenght and severity during recessions?

In this lecture:

 Basic stylized facts regarding business cycles.

 The model most economists use to explain business cycles: aggregate supply and aggregate
demand.

Short-Run Economic Fluctuations

Economic activity fluctuates from year to year

 In most years production of goods and services rises.

 On average over the past 50 years, production in the U.S. economy has grown by about 3 percent
per year.
 In some years normal growth does not occur, causing a recession.

*Recession: a period of declining real incomes, and rising unemployment.

*Depression: A severe recession.

THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

1. Economic fluctuations are irregular and unpredictable.

 Fluctuations in the economy are often called the business cycle.
2. Most macroeconomic variables fluctuate together
 Most macroeconomic variables that measure some type of income, spending or production
fluctuate closely together.
 When real GDP falls in a recession, so do personal income, corporate profits, consumer
spending, investment spending, industrial production, retail sales….
 Although they fluctuate by different amounts.
 In particular, investment spending varies greatly over the business cycle.
3. As output falls, unemployment rises
 Changes in real GDP are inversely related to changes in the unemployment rate (Okun’s
law*).
 *In order to keep the unemployment rate steady, real GDP needs to grow at or close to its
potential.
 *That is, in order to reduce the unemployment rate by 1 per cent in a year, real GDP must
rise by around 2 per cent more than potential GDP over the year.
 During times of recession, unemployment rises substantially.

How the Short Run Differs from the Long Run

Up to now: theories to explain what determines most important macroeconomic variables in the long run.

All the previous analysis was based on two related ideas:

1. The Classical Dichotomy, i.e. the separations of variables into real variables (those that measure quantities
or relative prices) and nominal variables (those measured in terms of money).
2. The Monetary Neutrality, i.e. the proposition that changes in the money supply affect nominal but not real
variables
  As a result of this monetary neutrality, we could examine the determinants of real variables (real
GDP, the real interest rate and unemployment) without introducing nominal variables ( money
supply and the price level ).

Most economists believe that classical theory describes the world in the long run but not in the short run. Beyond
a period of several years, changes in the money supply affect prices and other nominal variables but do not affect
real GDP, unemployment or other real variables.

Conventional wisdom:

 The assumption of monetary neutrality is not appropriate when studying year-to-year changes in the
economy.
 In the short run, real and nominal variables are highly intertwined.
 In particular, changes in money supply can temporarily push output away from its long run trend.

The Basic Model of Economic Fluctuations

Two variables are used to develop a model to analyse the short-run fluctuations.

 The economy´s output of goods and services measured by real GDP.

 The overall price level measured by the CPI or the GDP deflator.

Notice that output is a real variable, whereas the price level is a nominal variable. Hence, by focusing on the
relationship between these two variables, we are highlighting the breakdown of the classical dichotomy

Model of Aggregate Demand and Aggregate Supply: the model that most economists use to explain short-run
fluctuations in economic activity around its long-run trend.

The aggregate-demand curve shows the quantity of goods and services that households, firms, and the government
want to buy at each price level.

The aggregate-supply curve shows the quantity of goods and services that firms choose to produce and sell at each
price level.

According to this model, the price level and the quantity of output adjust to bring AD and AS into balance.

It may be tempting to view the model of AD and AS as nothing more than a large version of the model of
market demand and market supply. Yet in fact this model is quite different:

 When we consider demand and supply in a particular market for a good such as tablet computers,
the behaviour of buyers and sellers depends on the ability of resources to move from one market to
another. When the price of tablet computers rises, the quantity demanded falls because buyers will
use their incomes to buy products other than tablets. Similarly, a higher price of tablets raises the
quantity supplied because firms that produce these gadgets can increase production by hiring
workers away from other parts of the economy.
 This microeconomic substitution from one market to another is impossible when we are analysing
the economy as a whole. After all, the quantity that our model is trying to explain – real GDP –
measures the total quantity produced in all of the economy’s markets
THE AGGREGATE DEMAND (AD) CURVE

The AD curve is downwards sloping reflecting the inverse relationship between the price level and
national income.

To understand the AD curve, recall GDP (Y) is made up of four components: consumption (C), investment
(I), government purchases (G) and Net Exports (NX).

Y = C +I +G +NX

Government purchases are assumed to be fixed by policy. The other three components of spending
depend on economic conditions and, in particular, on the price level.

To understand why the aggregate demand curve slopes downward, we must understand how changes in
the price level affect:

1. Consumption  The Wealth Effect

2. Investment  The Interest Rate Effect
3. Net exports  The Exchange Rate Effect
Why the Aggregate Demand Curve Slopes Downward

1. The Price Level and Consumption: The Wealth Effect

 A decrease in the price level makes consumers feel more wealthy, which in turn encourages them to spend
more.
 This increase in consumer spending means larger quantities of goods and services demanded.

2. The Price Level and Investment: The Interest Rate Effect

 When the price level is lower, households need less money for transaction and therefore try to reduce their
holdings of money by lending some out (either in financial markets or through financial intermediaries).
 This increases the supply of loanable funds and reduce the interest rate.
 Lower interest rates encourage borrowing by firms that want to invest in new plants and equipment and by
households who want to invest in new housing.
 Thus, a lower price level reduces the interest rate, encourages greater spending on investment goods, and
thereby increases the quantity of goods and services demanded.

3. The Price Level and Net Exports: The Exchange Rate Effect

 As seen before, a lower price level lowers the interest rate, which in turn increases net capital outflows
(NCO).
 Some investors will seek higher returns by investing abroad, increasing net capital outflows.
 The increase in net capital outflow raises the supply of domestic currency to the foreign currency exchange
market, lowering the real exchange rate.
  The economy´s goods become relatively cheaper relative to foreign goods.
Exports rise, imports fall, and net exports increase.

Summary : There are, therefore, three distinct but related reasons why a fall in the price level increases the quantity
of goods and services demanded: (1) consumers are wealthier, which stimulates the demand for consumption
goods; (2) interest rates fall, which stimulates the demand for investment goods; and (3) the exchange rate
depreciates, which stimulates the demand for net exports. For all three reasons, the AD curve slopes downwards.

All three of these effects imply that, all else equal, there is an inverse relationship between the price level and the
quantity of G&S demanded.

Why the Aggregate Demand Curve Might Shift

The downward slope of the aggregate demand curve shows that a fall in the price level raises the overall quantity
of goods and services demanded.

Many other factors, however, affect the quantity of goods and services demanded at any given price level.

When one of these other factors changes, the aggregate demand curve shifts.

Shifts arising from:

 Consumption
 Examples: people become more concerned about saving for retirement (the AD curve shifts to the left);
stock market boom (the AD curve shifts to the right); income taxation.
 the level of taxation: When the government cuts taxes, it encourages people to spend more, so the AD curve
shifts to the right. When the government raises taxes, people cut back on their spending and the AD curve
shifts to the left.
 Investment
 Examples: discovery of new technology (the AD curve shifts to the right); pessimism about future business
conditions (, the AD curve shifts to the left), investment tax credit (a tax rebate tied to a firm’s investment
spending) increases the quantity of investment goods that firms demand at any given interest rate. It
therefore shifts the AD curve to the right. The repeal of an investment tax credit reduces investment and
shifts the AD curve to the left.
 Monetary policy: An increase in money supply lowers the interest rate in the short run and thus leads to
higher investment (shifts the AD curve to the right). A decrease in money supply raises the interest rate,
discourages investment spending and shifts the AD curve to the left.
 Government Purchases
 The most direct way that policymakers shift the AD curve is through government purchases.
 Examples: the government reduces purchase of new weapons systems. Because the quantity of goods and
services demanded at any price level is lower, the AD curve shifts to the left.
 The government builds new motorways. The result is a greater quantity of goods and services demanded at
any price level, so the AD curve shifts to the right.
 Net Exports
  Examples: Recession in US. It buys fewer goods from Europe. This reduces European net exports and shifts
the AD curve for the European economy to the left. When the US recovers from its recession, it starts buying
European goods again, shifting the AD curve to the right.
 Net exports sometimes change because of movements in the exchange rate. Example: Speculators bid up
the value of the euro. This appreciation of the euro would make goods produced in the euro area more
expensive compared to foreign goods, which would depress net exports and shift the AD curve to the left.
Conversely, a depreciation of the euro stimulates net exports and shifts the euro area AD curve to the right.

The AD Curve: Summary

Why does the AD curve slope downward?

1. The wealth effect: A lower price level increases real wealth, which encourages spending on consumption.
2. The interest-rate effect: A lower price level reduces the interest rate, which encourages spending on
investment.
3. The exchange-rate effect: A lower price level causes the real exchange rate to depreciate, which encourages
spending on net exports.

Why might the AD curve shift?

1. Shifts arising from consumption: An event that makes consumers spend more at a given price level (a tax
cut, a stock market boom) shifts the AD curve to the right. An event that makes consumers spend less at a
given price level (a tax hike, a stock market decline) shifts the AD curve to the left.
2. Shifts arising from investment: An event that makes firms invest more at a given price level (optimism about
the future, a fall in interest rates due to an increase in the money supply) shifts the AD curve to the right. An
event that makes firms invest less at a given price level (pessimism about the future, a rise in interest rates
due to a decrease in the money supply) shifts the AD curve to the left.
3. Shifts arising from government purchases: An increase in government purchases of goods and services
(greater spending on defence or motorway construction) shifts the AD curve to the right. A decrease in
government purchases on goods and services (a cutback in defence or motorway spending) shifts the AD
curve to the left.
4. Shifts arising from net exports: An event that raises spending on net exports at a given price level (a boom
overseas, an exchange rate depreciation) shifts the AD curve to the right. An event that reduces spending on
net exports at a given price level (a recession overseas, an exchange rate appreciation) shifts the AD curve to
the left.

THE AGGREGATE SUPPLY (AS) CURVE

The AS curve tells us the total quantity of goods and services that firms produce and sell at any given price level.

The AS shows a relationship that depends crucially on the time horizon being examined.

 In the long run, the aggregate supply curve is vertical.

 In the short run, the aggregate supply curve is upward sloping.

To understand short-run economic fluctuations, and how the short-run behaviour of the economy deviates from its
long-run behaviour, we need to examine both the long-run AS curve and the short-run AS curve.
 1. Why the Aggregate Supply Curve Is Vertical in the Long Run

In the long run, an economy’s production of goods and services (its real GDP) depends on its supplies of labour,
capital and natural resources, and on the available technology used to turn these factors of production into goods
and services.

Because the price level does not affect these determinants of output in the long run, the long-run aggregate supply
curve is vertical.

 The vertical long-run AS curve is, in essence, just an application of the classical dichotomy and monetary
neutrality. Classical macroeconomic theory is based on the assumption that real variables do not depend on
nominal variables. The long-run AS curve is consistent with this idea because it implies that the quantity of
output (a real variable) does not depend on the level of prices (a nominal variable).
 Most economists believe that this principle works well when studying the economy over a period of many
years, but not when studying year-to-year changes. Thus, the AS curve is vertical only in the long run.

Why the Long-Run Aggregate Supply Curve Might Shift

The position of the aggregate supply curve occurs at an output level sometimes referred to as potential output or
full-employment output.(fully utilized).

 This is the level of output that the economy produces when unemployment is at its natural rate.

Any change in the economy that alters the natural rate of output shifts the long-run aggregate supply curve.

 Shifts Arising from Labour (immigration, changes in the natural rate of unemployment)
 Shifts Arising from Capital (increases in human or physical capital stock).
 Shifts Arising from Natural Resources (discovery of new mineral deposit, change in the availability of
imported resources - e.g. oil).
 Shifts Arising from Technological Knowledge (invention of new computers, international trade).

A New Way to Represent Long-Run Growth and Inflation

Having introduced the economy ’s AD curve and the long-run AS curve, we now have a new way to describe the
economy ’s long-run trends.

‘The model provides a new way to describe the long-run dynamics of an economy.

Although there are many forces that govern the economy in the long run and can in principle cause such shifts, the
two most important forces that govern the economy in the long run are technological progress and monetary
policy.

 Technological progress shifts long-run aggregate supply to the right.

  The Central Bank increases the money supply over time, which raises aggregate demand.

The result is growth in output and continuing inflation (increases in the price level).

Nota bene: Short-run fluctuations in output and price level should be viewed as deviations from the continuing long-
run trends.

2. Why the Aggregate Supply Curve Slopes Upward in the Short Run

Key difference between the economy in the short run and in the long run: the behaviour of AS.

In the short run the AS curve is upward sloping: an increase in the overall price level tends to raise the quantity of
goods and services supplied in the economy, and viceversa.

Three theories have been proposed to explain this relationship:

1. The Sticky Wage Theory

2. The Sticky Price Theory
3. The Misperception Theory

In each theory, a specific market imperfection causes the supply side of the economy to behave differently in the
short run than it does in the long run.

They share a common theme: output supplied deviates from its long-run, or natural, level when the price level
deviates from the price level that people expected to prevail.
When the price level rises above the expected level, output rises above its natural rate, and When the price level
falls below the expected level, output falls below its natural rate.

1. The Sticky Wage Theory

The short-run AS curve slopes upwards because nominal wages are slow to adjust, or are sticky.

The slow adjustment of nominal wages is attributable to long-term contracts between workers and firms that fix
nominal wages, sometimes for as long as three years. It may be attributable to social norms and notions of fairness
that influence wage setting and that change only slowly over time.

 Wages do not adjust immediately to a fall in the price level.

 A lower price level makes employment and production less profitable.
 This induces firms to reduce the quantity of goods and services supplied.

Further explanation: To see what sticky nominal wages mean for AS, imagine that a firm has agreed in advance to
pay its workers a certain nominal wage based on what it expected the price level to be.

 If the price level P falls below the level that was expected and the nominal wage remains stuck at W, then
the real wage W/P rises above the level the firm planned to pay.
 Because wages are a large part of a firm’s production costs a higher real wage means that the firm’s real
costs have risen.
 The firm responds to these higher costs by hiring less labour and producing a smaller quantity of goods and
services.

A Simple Model of the Aggregate Supply

 Wage setting mechanism:

The nominal wage Wt depend positively on expected price level (agents care about the real wage) and on
business cycle conditions.

 Price setting equation:

where µt denotes the markup charged by producing firms and St is a cost push shock (e.g. a oil price shock)

 Putting the two together:

which holds true at all periods t.

 Taking logs and using the approximation log(1+xt) ≈ Xt we get

where lowercase letters denote logs of the corresponding uppercase letter, e.g.
pt = logPt.
  is a cost-push shock. There is a positive relation between prices and output - a "menu
choice" of policy - BUT it depends on expected prices.
 If agents expect higher prices, they demand higher nominal wages and this translate into higher prices today

Aggregate Supply and Phillips Curve

 The aggregate supply is a relation between prices and output:

 Finally, noticing that there is a negative relationship between output gap, and unemployment (the so called
Okun´s Law).

one gets the Phillips Curve:

2. The Sticky Price Theory

Prices of some goods and services adjust sluggishly in response to changing economic conditions.

 This is often blamed on menu costs: These menu costs include the cost of printing and distributing price lists
or mail-order catalogues and the time required to change price tags. As a result of these costs, prices as well
as wages may be sticky in the short run.

Suppose that each firm in the economy announces its prices in advance based on the economic conditions it expects
to prevail. Then, after prices are announced, the economy experiences an unexpected contraction in the money
supply, which will reduce the overall price level in the long run. Although some firms reduce their prices immediately
in response to changing economic conditions, other firms may not want to incur additional menu costs and,
therefore, may temporarily lag behind. Because these lagging firms have prices that are too high, their sales decline.
Declining sales, in turn, cause these firms to cut back on production and employment.

In other words, an unexpected fall in the price level leaves some firms with higher-than-desired prices.

This depresses sales, which induces firms to reduce the quantity of goods and services they produce.

3. The Misperceptions Theory

Changes in the overall price level can temporarily mislead suppliers about what is happening in the markets in which
they sell their output.

As a result of these misperceptions, suppliers respond to changes in the level of prices and thus, the short-run
aggregate supply curve is upward sloping.

Example: The price level falls unexpectedly.

 Suppliers mistakenly believe that as the price of their product falls, it is a drop in the relative price of their
product.
 Suppliers may then believe that the reward of supplying their product has fallen, and thus they decrease the
quantity that they supply.
 The same misperception may happen if workers see a decline in their nominal wage (caused by a fall in the
price level).
The Short Run AS Curve: Summary

All these three theories suggest that output deviates from its natural level whenever the price level deviates from
the price level that people expected.

Mathematically:

where Y is output supplied, ¯ Y the natural rate of output, P the actual price level and Pe the expected price level.

NB: the effects of the change in the price level will be temporary. Eventually people will adjust their price level
expectations and output will return to its natural level.

 The AS curve will be vertical in the long run.

Why the Short Run AS Curve Might Shift

When thinking about what shifts the short-run AS curve, we have to consider all those variables that shift the long-
run AS curve plus a new variable – the expected price level – that influences sticky wages, sticky prices and
misperceptions.

1. Events that shift the long-run aggregate supply curve will shift the short-run aggregate supply curve as well.

 Shift arising from labour, capital, natural resources, technology.

Examples:

 An increase in the economy’s capital stock increases productivity, both the long-run and short-run AS curves
shift to the right.
 An increase in the minimum wage raises the natural rate of unemployment, both the long-run and short-run
AS curves shift to the left.

2. Important new variable: the expectations of the price level. The quantity of G&S supplied depends in the
short-run on sticky wages, sticky prices and misperceptions. Yet wages, prices and perceptions are set on the
basis of expectations of the price level. So when expectations change, the short-run AS curve shifts.

 A higher expected price level reduces the quantity of g&s supplied and shifts the short-run AS to the left.
 A lower expected price level raises the quantity of g&s supplied and shifts the short-run AS to the right.

NB: This influence of expectations on the position of the short run AS plays a crucial role in reconciling the short-run
with the long-run.

In the short run, expectations are fixed, and the economy finds itself at the intersection of the AD curve and the
short-run AS curve.
In the long run, expectations adjust, and the short-run AS curve shifts. This shift ensures that the economy
eventually finds itself at the intersection of the AD curve and the long-run AS curve.

The Long Run Equilibrium

At the long-run equilibrium, wages, prices and perceptions will have adjusted so that the short-run AS curve crosses
point A as well.

The Short-Run Aggregate Supply Curve: Summary

Why does the short-run aggregate supply curve slope upward?

1. The sticky wage theory : An unexpectedly low price level raises the real wage, which causes firms to hire
fewer workers and produce a smaller quantity of goods and services.
2. The sticky price theory : An unexpectedly low price level leaves some firms with higherthan-desired prices,
which depresses their sales and leads them to cut back production.
3. The misperceptions theory : An unexpectedly low price level leads some suppliers to think their relative
prices have fallen, which induces a fall in production.

Why might the short-run aggregate supply curve shift?

1. Shifts arising from labour : An increase in the quantity of labour available (perhaps due to a fall in the
natural rate of unemployment) shifts the AS curve to the right. A decrease in the quantity of labour available
(perhaps due to a rise in the natural rate of unemployment) shifts the AS curve to the left.
2. Shifts arising from capital : An increase in physical or human capital shifts the AS curve to the right. A
decrease in physical or human capital shifts the AS curve to the left.
3. Shifts arising from natural resources : An increase in the availability of natural resources shifts the AS curve
to the right. A decrease in the availability of natural resources shifts the AS curve to the left.
4. Shifts arising from technology : An advance in technological knowledge shifts the AS curve to the right. A
decrease in the available technology (perhaps due to government regulation) shifts the AS curve to the left.
5. Shifts arising from the expected price level : A decrease in the expected price level shifts the short-run AS
curve to the right. An increase in the expected price level shifts the short-run AS curve to the left.

TWO CAUSES OF SHORT-RUN ECONOMIC FLUCTUATIONS

We will study two - very broad - causes for economic fluctuations:

1. The effect of a shift in AD (Demand Shock)

 Examples: stock market boom/burst, animal spirits...
2. The effect of a shift in AS (Supply Shock)
 Examples: oil shocks, productivity shocks...
The Effects of a Shift in Aggregate Demand

Suppose a wave of pessimism overtaking the economy caused by a government scandal, a crash on the stock market
or the outbreak of war overseas. Households cut back on their spending and delay major purchases, and firms put
off buying new equipment. Reduction of consumption and investment: the AD shifts to the left.

In the short run, both output and prices fall. This drop in output means that the economy is in a recession.

What should policymakers do when faced with such a recession?

Two Cases:

1. Policy makers increase government spending and/or increase money supply

 The AD shifts back to the right
2. Policy makers do nothing
 as soon as people correct their expectations about prices, the expected price level falls shifting the
AS curve to the right.

In the short run, shifts in aggregate demand cause fluctuations in prices and in output.

 Monetary and fiscal policy can be useful to avoid/reduce the gravity of recessions

The long-run effect of a change in aggregate demand is a nominal change (in the price level) but not a real change
(output is the same).

 In the long run, the decrease in aggregate demand can be seen solely by the drop in the equilibrium
price level.

The Effects of a Shift in Aggregate Supply

Example: Firms experience a sudden increase in their costs of production.

This will cause the short-run aggregate supply curve to shift to the left. (Depending on the event, long-run aggregate
supply may also shift. We will assume that it does not.)

 Output falls below the natural rate of employment, unemployment rises, the price level rises.

In the short run, output will fall and the price level will rise. The economy is experiencing stagflation.

 Stagflation: a period of falling output (stagflation) and rising prices (inflation).

Policy Responses to Recession

Policymakers may respond to a recession in one of the following ways:

 Do nothing and wait for prices and wages to adjust.

 Take action to increase aggregate demand by using monetary and fiscal policy

NB: in any case, policymakers who can influence aggregate demand cannot offset both of these adverse effects
simultaneously.

CONCLUSION

This chapter has achieved two goals. First, we have discussed some of the important facts about short-run
fluctuations in economic activity. Second, we have introduced a basic model to explain those fluctuations, called
the model of AD and AS. We continue our study of this model in the next chapter in order to understand more fully
what causes fluctuations in the economy and how policymakers might respond to these fluctuations.

SUMMARY

1. All societies experience short-run economic fluctuations around long-run trends. These fluctuations are irregular and
largely unpredictable. When recessions do occur, real GDP and other measures of income, spending and production fall,
and unemployment rises.
2. Economists analyse short-run economic fluctuations using the model of AD and AS. According to this model, the output
of goods and services and the overall level of prices adjust to balance AD and AS.
3. The AD curve slopes downwards for three reasons. First, a lower price level raises the real value of households’ money
holdings, which stimulates consumer spending. Second, a lower price level reduces the quantity of money households’
demand; as households try to convert money into interest-bearing assets, interest rates fall, which stimulates
investment spending. Third, as a lower price level reduces interest rates, the local currency depreciates in the market
for foreign currency exchange, which stimulates net exports.
4. Any event or policy that raises consumption, investment, government purchases or net exports at a given price level
increases AD. Any event or policy that reduces consumption, investment, government purchases or net exports at a
given price level decreases AD.
5. The long-run AS curve is vertical. In the long run, the quantity of goods and services supplied depends on the
economy’s labour, capital, natural resources and technology, but not on the overall level of prices.
6. Three theories have been proposed to explain the upwards slope of the short-run AS curve. According to the sticky
wage theory, an unexpected fall in the price level temporarily raises real wages, which induces firms to reduce
 employment and production. According to the sticky price theory, an unexpected fall in the price level leaves some
firms with prices that are temporarily too high, which reduces their sales and causes them to cut back production.
According to the misperceptions theory, an unexpected fall in the price level leads suppliers to mistakenly believe that
their relative prices have fallen, which induces them to reduce production. All three theories imply that output deviates
from its natural rate when the price level deviates from the price level that people expected.
7. Events that alter the economy’s ability to produce output, such as changes in labour, capital, natural resources or
technology, shift the short-run AS curve (and may shift the long-run AS curve as well). In addition, the position of the
short-run AS curve depends on the expected price level.
8. One possible cause of economic fluctuations is a shift in AD. When the AD curve shifts to the left, for instance, output
and prices fall in the short run. Over time, as a change in the expected price level causes wages, prices and perceptions
to adjust, the short-run AS curve shifts to the right, and the economy returns to its natural rate of output at a new,
lower price level.
9. A second possible cause of economic fluctuations is a shift in AS. When the AS curve shifts to the left, the short-run
effect is falling output and rising prices – a combination called stagflation. Over time, as wages, prices and perceptions
adjust, the price level falls back to its original level, and output recovers.
10. New Keynesian economics represents a research tradition that questions the classical dichotomy and recognizes
imperfections in the economy as key elements in explaining short run deviations from trend.