Long-Run Self-Adjustment

Why the economy heals itself

Short-run equilibrium can sit away from LRAS, but not forever. The mechanism is nominal wages and input prices, which are sticky in the short run and flexible in the long run.

• Recessionary gap. Unemployment is above the natural rate, so workers accept lower nominal wages. Production costs fall ⇒ SRAS shifts right until output returns to potential — at a lower price level.
• Inflationary gap. Labour is scarce, so nominal wages are bid up. Costs rise ⇒ SRAS shifts left until output returns to potential — at a higher price level.

What never moves

Self-adjustment moves only SRAS. AD stays put — nothing about it has changed — and LRAS stays put, because productive capacity has not changed either. Every long-run equilibrium ends at the same real GDP; only the price level differs.

The policy argument

If the economy fixes itself, why intervene? Because adjustment can be slow: nominal wages are especially resistant to falling, so a recessionary gap may last years. The counter-argument is that policy has lags of its own and may arrive after the gap has already closed.