Chapter 5: The Theory of Macroeconomic Policy
Keynes’s Moral Asymmetry Under conditions of perfect knowledge, when everyonein the market can calculate the approximate outcome of a change in the money supply, and everyone knows that everyone else can do the same, any increase in the money supply would cause an instantaneous and proportional increase in the rate of inflation without any change in the rate of interest. Monetary policy would therefore be completely ineffective because, as the quantity theory of money suggests, the price level would immediately change in proportion to the money supply. Likewise, and as the Ricardian equivalencetheory indicates, fiscal policy would have no macroeconomic effects in conditions of perfect knowledge. A ‘rational’ market would factor in the higher future taxes that would be required in the future to pay for any unfunded government spending, and the expansionary effects of a spending programme would be exactly neutralized by the prospective increases in taxation. Given tastes and perfect knowledge, any aberrant and individual actions in the market would be exactly and immediately offset by other individuals. A single item withdrawn from the market would be replaced by an identical item, and profittaking would mean that no decision-maker, government or private, would have any impact on the market outcome. However perfect knowledge is only one extreme; at the other extreme, if no one had any idea whatsoever of the general equilibrium consequences of monetary and fiscal policies, those policies could not be offset by market profit-taking. However such policies 96 The Theory of MacroeconomicPolicy 97 could never...
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