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An Important Inconsistency at the Heart of the Standard Macroeconomic Model


  • Wynne Godley
  • Anwar M. Shaikh


The standard neoclassical model is the foundation of most mainstream macroeconomics. Its basic structure dominates the analysis of macroeconomic phenomena, the teaching of the subject, and even the formation of economic policy. And of course the modern quantity theory of money and its attendant monetarist prescriptions are grounded in the model's strict separation between real and nominal variables. It is quite curious, therefore, to discover that this model contains an inconsistency in its treatment of the distribution of income which should become apparent if Walrus' law is appropriately articulated. And when this seemingly small discrepancy is corrected, without any change in all of the other assumptions, many of the model's characteristic results disappear. Two instances are of particular interest. First, the strict dichomoty between real variables and nominal variables breaks down, so that, for example, an increase in the exogenously given money supply changes real variables such as household income, consumption, investment, the interest rate, and hence real money demand. Secondly, since the price level depends on the interaction of real money demand and the nominal money supply, and since the former is now affected by the latter, price cahnges are no longer proportional to changes in the money supply. Indeed, we will demonstrate that prices can even fall when the money supply rises. The link to the quantity theory of money, and to monetarism, is severed. Patinkin in his classical work (1965) papers over the cracks in an unsatisfactory adhoc way.
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  • Wynne Godley & Anwar M. Shaikh, 1998. "An Important Inconsistency at the Heart of the Standard Macroeconomic Model," Economics Working Paper Archive wp_236, Levy Economics Institute.
  • Handle: RePEc:lev:wrkpap:wp_236

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    References listed on IDEAS

    1. Buiter, Willem H, 1980. "Walras' Law and All That: Budget Constraints and Balance Sheet Constraints in Period Models and Continuous Time Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 21(1), pages 1-16, February.
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    Cited by:

    1. Jamee K. Moudud, 2000. "Crowding In or Crowding Out? A Classical-Harrodian Perspective," Macroeconomics 0012001, EconWPA.
    2. Kakarot-Handtke, Egmont, 2012. "The rhetoric of failure: a hyper-dialog about method in economics and how to get things going," MPRA Paper 43276, University Library of Munich, Germany.
    3. Andrew Mearman, 2010. "What is this thing called ‘heterodox economics’?," Working Papers 1006, Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol.
    4. Michalis Nikiforos & Gennaro Zezza, 2017. "Stock-flow Consistent Macroeconomic Models: A Survey," Economics Working Paper Archive wp_891, Levy Economics Institute.
    5. Kakarot-Handtke, Egmont, 2012. "Intertwined real and monetary stochastic business cycles," MPRA Paper 42793, University Library of Munich, Germany.
    6. Li, Boyao, 2017. "The impact of the Basel III liquidity coverage ratio on macroeconomic stability: An agent-based approach," Economics Discussion Papers 2017-2, Kiel Institute for the World Economy (IfW).

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