ABSTRACT
This chapter develops a different approach to aggregate demand by viewing it in a graphical format that compares output to inflation. It introduces an aggregate demand (AD) curve which shows the effect of inflation on the macroeconomic equilibrium level. The view of aggregate demand assumes that higher inflation rates will tend to reduce total demand. The channel through which this happens differs for the type of economy in question. The chapter needs to distinguish between economies that have their own central bank that can set interest rates at its discretion and that have a floating exchange rate with other countries, and countries that are part of the euro area and hence cannot set their own interest rates. For countries with their own central bank and a floating exchange rate, the downward-sloping AD curve can be explained by the central bank's reaction to different levels of inflation.
