Assumptions

We see that the increase in aggregate demand has increased employment only temporarily, but it has increased the price level and inflationary expectations more or less permanently. And, indeed, by the definition of the NAIRGDP and the NAIRU, production cannot be above the NAIRGDP and unemployment below the NAIRU for very long without ever-increasing inflation. This sounds pretty bad for any policy aimed at expanding aggregate demand and thereby increasing employment.

But there is a hidden assumption here. Production has come back to the original level because we the NAIRGDP hasn't changed. That's an assumption, not a fact. It may seem a natural enough assumption -- after all, the term "long run supply" has a stable sound about it -- but the macroeconomic long run isn't quite the same as the microeconomic long run. We have defined long run supply as being the same as the NAIRGDP, the production just high enough (and the unemployment just high enough) that the rate of inflation is stable. When we say it that way, it might not seem quite as "natural" that the NAIRGDP is unchanged. For example: we remember that interest is a cost of investment. So a lower interest rate might, in itself, shift the aggregate supply curves to the right. ("Supply Siders" in political discussions tend to stress that possibility). That shift in the NAIRGDP might itself be temporary -- or it might not. And it might be so small that it wouldn't make any difference -- or it might not. So we have to qualify our conclusions a little: Unless the policy leads to shifts in long run supply as well as in demand, aggregate demand policy would have only a temporary effect.

Here's another point: In this example, the increase in aggregate demand was a result of an increase in the supply of money. Of course, that is not the only thing that could cause an increase in aggregate demand. An increase in aggregate demand could be caused by

An increase in autonomous consumption
An increase in investment from some other cause beside changing interest rates
An increase in government purchases of goods and services
A decrease in taxes
An increase in the size of a balanced budget

In each case the sequence of events would be broadly similar, in that increases in production beyond the NAIRGDP would be temporary, with leftward shifts of the SAS curve bringing production back to the NAIRGDP in the new long run equilibrium. Prices would rise more in the long run than in the short. Some details, such as the change in interest rates, might vary from one case to another.

But now let's look at a case of the opposite kind: a reduction in aggregate demand.

Decreasing Aggregate Demand