Working Paper: NBER ID: w0894
Authors: Bennett T. McCallum
Abstract: A Keynesian idea of considerable historical importance is that, in the presence of a liquidity trap, a competitive economy may lack--despite price flexibility--automatic market mechanisms that tend to eliminate excess supplies of labor. The standard classical counterargument, which relies upon the Pigou effect, has typically been conducted in a comparative-static framework. But, as James Tobin has recently emphasized, the more relevant issue concerns the dynamic response (in "real time") of an economy that has been shocked away from full employment. The present paper develops a dynamic analysis, in a rather standard model, under the assumption that expectations are formed rationally. The analysis permits examination of Tobin's suggestion that, because of expectational effects, such an economy could be unstable. Also considered is Martin J. Bailey's conjecture that, in the absence of a stock Pigou effect, Keynesian problems could be eliminated by expectational influences on disposable income.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Pigou effect (D62) | economic stability (E63) |
| capital gains effect (H31) | economic stability (E63) |
| expected inflation (E31) | disposable income (D10) |
| disposable income (D10) | aggregate demand (E00) |
| aggregate demand (E00) | output (C67) |
| absence of Pigou effect and capital gains effect (H31) | price level indeterminacy (E30) |
| absence of Pigou effect and capital gains effect (H31) | output overdetermination (C67) |