Our brief review of modern economic history high lights some of the crucial forces that impinge upon the macroeconomy. Some of the forces operate on the spending side, changing aggregate demand because of changes in consumer preferences or military expenditures. Other disturbances arise on the supply side, as when a revolution leads to a doubling of oil prices or when bad harvests lead to major food-price increases.
The major task of macroeconomic policy today is to diagnose the different ailments affecting aggregate supply and demand and to prescribe the appropriate policies. In some cases, policymakers face no dilemmas. If the economy is operating at potential output, and if the President signs an accord with the Soviet Union leading to deep cuts in military spending, then the diagnosis is straightforward. The military cuts would tend to decrease aggregate demand; most economists would agree that economic policy should respond by taking measures to offset the spending cut using monetary or fiscal policy to increase aggregate demand.
Other kinds of shocks pose more difficult policy questions, and in some cases these seem to be irreconcilable dilemmas. What would be the appropriate response if global weather patterns in 1988 produced a terrible drought, sending food prices sky-high? AS aggregate supply contracted (in a manner shown in Figure 5-10), should policymakers “accommodate" the price rise by increasing aggregate demand to prevent any output loss? Or should economic policy be “nonaccommodative,” contracting aggregate demand to prevent any increase in the overall price level? An accommodative policy will lead to high inflation and low unemployment; a nonaccommodative approach will produce an economic downturn and high unemployment while preventing rising prices.
Which approach is the correct one? Economics can provide no scientifically correct answer to such questions, for they are normative issues involving dilemmas of social and political values. But economics can strive to answer positive questions, providing quantitative estimates of the gains and losses from inflation and unemployment associated with different policy approaches. Then the political leaders must make the ultimate choices.