I want to show a couple of time series for the AS-ED model (Aggregate supply-Effective demand). Each time series consists of 6 consecutive quarters.

First this is the time series from 1stQ-2010 to 2ndQ-2011. Just follow the arrows from quarter to quarter.

A couple of simple things to notice here...

- The blue dots (real GDP and inflation rate) show that the inflation rate was falling and then ticked back up while output increased.
- The red dots (Natural level of real GDP price level) were declining and then rose back up. They reached bottom when the lower bound of the ED rule was reached.
- The green dots (Effective demand price level) show that effective demand was falling and then rose.

Now we will look at the last 6 quarters, from 4Q-2011 to 1Q-2013. (1Q-2013 uses an estimate of effective labor share, which has not been released as of today's date.)

A couple of things to notice here...

- The blue dots (real GDP and inflation rate) show that the inflation rate was falling and then has held steady for the past 4 quarters. Aggregate supply has continued to shift right (increase).
- The red dots (Natural level of real GDP price level) are basically moving down the effective demand curve. For the last 4 quarters, the price level of the red dots has been sitting on the lower bound of the Effective demand rule for the Fed rate.
- The green dots (Effective demand price level) show that effective demand fell a year ago and then effective demand has not changed much in the past 4 quarters. Basically, aggregate supply is shifting right, but effective demand is not shifting much. Thus as output increases, the effective demand limit is lowering steadily according to its slope. Eventually effective demand will simply limit output and a contraction will result to push effective demand back up. At this rate, effective demand will limit output approximately around a real GDP of $14.050 trillion.
- We can gather from the green dots that unit labor costs are declining in relation to increased utilization of labor and capital. but we can also conclude from a non-shifting effective demand curve and a stable inflation rate, that effective labor share is stable.
- If unit labor costs rise, both the aggregate supply curve and the effective demand curve will rise in unison. If inflation stays the same, we will have a contraction. If inflation rises, we can avoid a contraction. The true secret to raising inflation is to slowly raise labor share and then let inflation catch up.

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