P Y Aggregate demand Aggregate supply Neoclassical synthesis

time PCA Effects of a real depreciation: “J-curve”. (in this case the terms of trade effects dominates to begin with, so that M-L does not hold for the first periods aftet the depreciation) M-L condition holds form “day one”

π Y Short-run AD Short-run AS Simultaneous short and long-run equilibrium See fig 13.4 in B&W PPP line Long-run supply curve (LAS)

π Y AD AS A B Devaluation Short-run: A to B. Long-run: A Dynamics: Depends on how core inflation is affected by devaluation

π Y AD AS A B Devaluation If core inflation is uaffected by devaluation: Back ”along” AS curve If core inflation is affected, then AS curve shifts

π Y AD AS A B Fiscal policy Short-run: A to B. Long-run: A Dynamics: Again depends on how core inflation is affected The “vertical” shift in the AD curve (for fixed Y)

π Y AD-fixed AS Regime dependent short-run effects of fiscal policy AD-float