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Inside and Outside Money, Gains to Trade, and IS-LM

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  • P. Dubey

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  • J. Geanakoplos
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    Abstract

    We build a one-period general equilibrium model with money. Equilibrium exists, and fiat money has positive value, as long as the ratio of outside money to inside money is less than the gains to trade available at autarky. We show that the nominal effects of government fiscal and monetary policy can be completely described by a diagram identical in form to the IS-LM curves introduced by Hicks to describe Keynes' general theory. IS-LM analysis is thus not incompatible with full market clearing, multiple commodities, and heterogeneous households. We show that as the government deficit approaches a finite threshold, hyperinflation sets in (prices converge to infinity and real trade collapses). If the government surplus is too large, the economy enters a liquidity trap in which nominal GNP sinks and monetary policy is ineffectual.

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    File URL: http://www.sunysb.edu/economics/research/papers/2001/01-08.pdf
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    Bibliographic Info

    Paper provided by Stony Brook University, Department of Economics in its series Department of Economics Working Papers with number 01-08.

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    Length: 55 pages
    Date of creation: 2001
    Date of revision:
    Handle: RePEc:nys:sunysb:01-08

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    1. Balasko, Yves & Cass, David, 1989. "The Structure of Financial Equilibrium with Exogenous Yields: The Case of Incomplete Markets," Econometrica, Econometric Society, vol. 57(1), pages 135-62, January.
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    Cited by:
    1. Andreas Schabert, 2004. "On the relevance of open market operations for the short-run effects of monetary policy," Money Macro and Finance (MMF) Research Group Conference 2003 83, Money Macro and Finance Research Group.

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