Rethinking equilibrium conditions in macromonetary theory: A conceptually rigorous approach

25 September 2012
Publication Type: Working Paper
JEL Code: E02, E11, E12, E40

Although still very much a minority view, there is a growing sense of unease about the high degree of abstraction involved in contemporary macro-monetary theory, in particular concerning its representative-agent microfoundation (see e.g. Colander et al., 2008; Goodhart, 2005, 2008; Buiter, 2009; Caballero, 2010; Hoover, 2010; Du Plessis, 2010; Meeusen, 2010). The paper shares this unease but questions another aspect of contemporary theory: its equilibrium conditions as consisting of its market coordination conditions and budget equation. The paper derives, from scratch, an alternative set of such conditions which it rigorously grounds in the nature of monetary exchange. This alternative set has implications for a wide variety of issues, including the aptness of MIU and CIA modelling, the nature of real and monetary disturbances, and the linkage between the financial and real sectors. The paper also assesses the conceptual soundness of commonly used constructs like Keynes’s income-spending (saving-investment) equation of IS analysis, Hicks’s wealth constraint, Fisher’s quantity equation, Walras’s Law, and the budget constraint of contemporary DSGE modelling.

Working Paper 255
1 November 2011