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Monetary Theory

Alan A. Rabin

Alan Rabin argues that new Keynesian and new classical macroeconomics, which have dominated the literature and textbooks, have crowded the monetary-disequilibrium hypothesis, or orthodox monetarism, off the intellectual stage. Trying to remedy this imbalance, the author concentrates on what he judges to be the essentials of monetary theory.
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Chapter 3: Money’s Demand and Supply: Equilibrium and Disequilibrium (1)

Alan A. Rabin


INTRODUCTION Monetary equilibrium and disequilibrium figure among the most important yet most misunderstood concepts of money/macro theory. Money in excess supply or demand can have momentous consequences for the economy. When the actual quantity of money exceeds or falls short of the total of cash balances demanded at existing prices, things happen that tend to restore equilibrium eventually. Instead of adjusting promptly to their new market-clearing levels, many prices and wages are ‘sticky’, and for reasons that make excellent sense to individual price-setters and wage-negotiators. Consequently, adjustment in the short run involves quantities (output, real income and employment) rather than prices alone. Throughout we emphasize the interdependence of nonclearing markets and the role of prices and wages in achieving or obstructing coordination. Our analysis fills a void mentioned by Robert Gordon (1990b, pp. 1137–8) in his exposition of new Keynesian economics: An interesting aspect of recent U.S. new-Keynesian research is the near-total lack of interest in the general equilibrium properties of non-market-clearing models. That effort is viewed as having reached a quick dead end after the insights yielded in the pioneering work of Barro and Herschel Grossman (1971, 1976), building on the earlier contributions of Don Patinkin (1965), Clower, and Leijonhufvud...Much newKeynesian theorizing is riddled with inconsistencies as a result of its neglect of constraints and spillovers... For purposes of exposition we divide monetary-disequilibrium theory into two components. The first focuses on disequilibrium between the demand for and supply of money and explains money’s role in determining nominal income....

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