Suppose that all households hold all their wealth in assets that automatically rise in value when the aggregate price level rises (an example of this is what is called an "inflation-indexed bond"-a bond whose interest rate, among other things, changes one-for-one with the inflation rate). What happens to the wealth effect of a change in the aggregate price level as a result of this allocation of assets? What happens to the slope of the aggregate demand curve? Will it still slope downward? Explain.

The wealth effect is the change in consumption that results from a change in perceived wealth due to a change in the aggregate price level. In other words, when the aggregate price level increases, the real value of wealth decreases, leading to a decrease in consumption and vice versa. The aggregate demand curve is a graphical representation of the relationship between the aggregate price level and the quantity of goods and services demanded by households, businesses, the government, and foreign consumers. It shows the total amount of goods and services that would be demanded at different price levels. Typically, the aggregate demand curve slopes downward, indicating that as the price level falls, the quantity of goods and services demanded increases, and vice versa.

When the aggregate price level changes, it affects the real value of wealth held by households. If the price level increases, the real value of wealth decreases, leading to a reduction in consumption. This reduction in consumption results in a downward movement along the aggregate demand curve, indicating a negative relationship between the price level and the quantity of goods and services demanded. Conversely, if the price level decreases, the real value of wealth increases, leading to an increase in consumption. This increase in consumption results in an upward movement along the aggregate demand curve, indicating a positive relationship between the price level and the quantity of goods and services demanded.

If all households hold their wealth in assets that automatically rise in value when the aggregate price level rises, such as inflation-indexed bonds, the wealth effect is neutralized. This means that changes in the aggregate price level will not significantly impact the real value of wealth held by households. As a result, consumption levels will not be affected by changes in the aggregate price level. Since the wealth effect is neutralized, the negative relationship between the aggregate price level and the quantity of goods and services demanded no longer holds. Therefore, the slope of the aggregate demand curve would be less steep or potentially horizontal. This means that changes in the price level will not result in significant changes in the quantity of goods and services demanded, and the aggregate demand curve may not necessarily slope downward anymore.