Outline your understanding of households’ and firms’ most likely responses to a fall in the aggregate demand for commodities. Does its perceived duration matter? If a downturn in the economy leads to a fall in demand that is perceived to be significant in magnitude and duration, discuss whether Walras’s law will continue to hold. If it does not, what happens to the excess demand for commodities and for bonds in the IS–LM model?

Does Walras’s law hold in recessions?