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Why Does Money Affect Output? A Survey

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  • Olivier J. Blanchard

Abstract

Why movements in nominal money appear to have strong and lasting effects on real activity is one of the most difficult questions in macroeconomics. The paper surveys the state of knowledge on the issue. with a focus on recent developments. The paper starts by reviewing the evolution of thought from Keynes' emphasis on wages to the "wage price mechanism" of the early 1970's. as well as the facts on the relation between money. prices and output. Prom this review. it concludes that the intellectual crisis of the 1970's came not from the inability of the prevailing theory to explain the facts -which it had mostly right-. but from the weakness of its theoretical foundations. The paper then examines the reconstruction effort. Two alternative strategies have been followed. The first has been to break with previous research and explore how far models based on perfect competition and imperfect information could go in explaining the effects of money on activity. This strategy has largely fizzled and its proponents moved away from the money-output issue. The second has been instead to explore whether the many insights of previous research could be made more rigorous and has focused on the potential role of imperfect competition in labor and goods markets ; substantial progress has been made. but no grand synthesis has emerged. nor is likely to in the foreseeable future.

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Bibliographic Info

Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 453.

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Date of creation: May 1987
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Handle: RePEc:mit:worpap:453

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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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