I disagree with Peter Dorman (HT Mark Thoma). I have used the AS-AD framework many times in my blog posts (and I don't remember anyone ever snickering at me for doing so) because I find it useful. Paul Krugman offers a partial defence of AS-AD, with the following caveat:
"So there is a place for AS-AD, although it’s an awkward one, and the transition to IS curve plus Taylor rule plus Phillips curve, which is the model you really want to use for America right now, is a moment that fills me with dread every time we take it on in a new edition."
I understand that dread. I know where he's coming from. But I have decided we need to face it down. Because it's a false dread.
Peter says that the AD curve assumes the money supply is fixed. It doesn't. Or rather, it doesn't have to. You don't need to make that assumption if you draw an AD curve. And any textbook that draws an AD curve for an open economy with fixed exchange rates certainly does not assume the money supply is fixed.
You get one AD curve if you assume the central bank targets the money supply. You get a different AD curve if you assume it targets the exchange rate. You get a third AD curve if you assume it targets NGDP (it's a rectangular hyperbola). A fourth AD curve if you assume it targets the price level (it's horizontal). A fifth AD curve if it targets (or tries to target) real GDP (it's vertical). A sixth AD curve if it targets (tries to target) a rate of interest (it's vertical again). And so on. (And if you draw a vertical AD curve and a vertical LRAS curve you can see immediately that something is wrong, and why I said "tries to target".)
For a modern central bank like the Bank of Canada, which targets an interest rate in the very short run, what it thinks is potential output in the medium run, and 2% inflation in the long run, you might want to draw a vertical short run and medium run AD curve, and a horizontal long run AD curve (though you might put the inflation rate rather than the price level on the vertical axis).
But when we teach economics we are not (or should not be) just teaching about the here and now. It's not just about America (or Canada) right now. My students come from all over the world, where monetary policies can be very different. And we want to teach a framework that can help them understand the past, and different possible futures, as well as the present. Canada has had fixed exchange rates in the past. It might switch to targeting NGDP in the future. I can show my students both those policies with a (different) AD curve. I cannot show them either of those policies with an IS curve plus Taylor Rule. (And the Bank of Canada does not currently follow a Taylor Rule anyway).
That's my defence of the AD curve. Now for the AS curve.
The biggest trouble with the AS curve is its name. Because only in a very limited class of models is it a supply curve. Because, strictly speaking, a "supply" curve tells you how much output firms want to sell, at any given price. If you've got sticky prices, and the economy is in recession, the economy might be on its SRAS curve, but firms will want to sell more output than they are actually selling. Even the LRAS curve isn't really a supply curve, if you have monopolistically competitive firms, because monopolistically competitive firms don't strictly have supply curves.
We should probably just call it "the other curve". But the "AS" name has stuck. Never mind. (And the AD curve isn't strictly a demand curve either, for that matter. Because, as the Old Keynesians taught us, but younger generations of New Keynesians might have forgotten, the level of output demanded depends on income, which depends on the amount of output actually sold, which depends on the amount of output demanded. So the AD curve is really a semi-equilibrium condition, showing points at which output equals output demanded, and unlike micro demand curves it does not tell us how much output will be demanded if we are off that curve).
If you believe (as most of us do) that prices are flexible in the long run but sticky in the short run then you get a LRAS which is normally vertical and a SRAS which isn't vertical. But the exact shape of that SRAS depends on what particular prices are sticky, and on many other features of the model.
Let me give one example. Suppose that in the short run all output prices are perfectly fixed. That gives you a horizontal SRAS curve. But does the SRAS curve extend to the right of the LRAS curve? That depends. If you have perfectly competitive firms that refuse to sell additional output if it's not profitable for them to do so, even if the demand is there, then the SRAS curve stops dead when it hits the LRAS curve. If you start on the LRAS curve and AD shifts right but prices are fixed, firms simply ration customers. But if you have monopolistically competitive firms the SRAS curve will continue to the right past the LRAS curve before it too eventually stops dead.
That's a big difference. You can show that difference with AS curves. You can't show that difference with a Phillips Curve.
Now you might say that the trouble with the SRAS curve is that the price level is on the vertical axis, rather than the inflation rate, which is what should be on the vertical axis if you have a Phillips Curve. Because prices may be sticky, but they are not stuck. OK, you have a point. But then the inflation rate isn't stuck either. And nor is the rate of change of the inflation rate stuck.
I call the insistence that we put inflation on the vertical axis the "fetish of the first derivative". There's nothing special about the first derivative. If you prefer Pdot to P, why stop there? You are off down a slippery slope to putting Pdoubledot on the vertical axis, then Ptripledot, and so on.
Unless you believe that the price level is a jump variable, and most of us don't (except maybe for a small subset of perfectly flexible prices), you ought to start out with the price level on the vertical axis. (And empirically, despite what the Calvo Phillips Curve says, inflation doesn't seem to be a jump variable either.) Yes, the SRAS curve will start shifting over time if the AD curve shifts. But so will the Short Run Phillips Curve. And so will the Short Run Phillipsdot curve. Forget the fetish of the first derivative. If 2% inflation and 3% real growth is normal in your time and place, just draw the AS-AD curves on a bit of paper, and tell your students to imagine that bit of paper is moving East-North-East at 5% per year. That's what I do.
So Paul: forget the dread. AS-AD is AOK.
(And any of you young DSGE-infused whippersnappers who even think of snickering might want to make very sure they actually understand AS-AD first!)