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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 6: Disequilibrium Economics (1)

Alan A. Rabin


THE MONETARY-DISEQUILIBRIUM HYPOTHESIS Among theories of macroeconomic fluctuations that accord a major role to money, at least three rivals have confronted each other. One is orthodox monetarism – ‘the monetary disequilibrium hypothesis’, as Warburton has called it (1966, selection 1, and elsewhere). A second is the so-called ‘Austrian theory of the business cycle’. A third is part of the ‘new classical macroeconomics’, which features two main hypotheses: ‘rational expectations’ and ‘equilibrium always’ (also known as continuous market-clearing or the Walrasian generalequilibrium model). This latter hypothesis consists of two strands: the theory of misperceptions in which money does have a role to play, and real business cycle theory. What monetarism offers toward understanding and perhaps improving the world becomes clearer when one compares it with its rivals. When monetary disequilibrium occurs, ‘things begin to happen’ that tend eventually to restore equilibrium. Instead of adjusting rapidly, however, prices and wages are ‘sticky’, so adjustment in the short run involves quantities rather than prices alone. Theories emphasizing an infectious failure of markets to clear have been criticized by adherents of the new classical macroeconomics. Yet a microeconomic rationale of disequilibrium behavior is available and will be presented here. It recognizes that most markets are not and cannot be perfectly competitive. It shares some strands with new Keynesian economics, which we review in the next section. NEW KEYNESIAN ECONOMICS New Keynesian economics contributes to our understanding of why prices and wages are sticky. It is a response to criticisms lodged by new classical economists that...

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