A Short Period Sraffa-Keynes Model for the Evaluation of Monetary Policy

This paper develops a short period, one sector, Sraffa-Keynes model that can be used for the evaluation of various recommendations outlined in the Post Keynesian monetary policy literature. The model is characterised by the principle of effective demand, Sraffa or target-return pricing (which integrates the determination of key distributive variables and allows for short run cyclical variation in prices), conflict inflation, endogenous money, and a basic approach to monetary policy in the Smithin�Wray tradition of fixing the policy rate to achieve low or specified rates of unemployment. The paper argues that nominal interest rates are the appropriate target for monetary policy rather than real rates given the need to determine appropriate rates of return on capital and the good approximation that nominal rates are for the particular specification that real rates take in the model. A number of key results arise from model simulations: after experiencing two standard macroeconomic shocks, the model returns to a long period equilibrium characterised by the achievement of the target rate of return, desired capacity utilisation, and Sraffian prices of production. Monetary policy is also shown to operate through the typical Post Keynesian transmission mechanism of changes to income distribution. Flexible prices (where firms modify prices to cover the additional costs of running the capital stock at other than full capacity) are lastly shown to have similar effects on activity to monetary policy. Suggestions are made for further work which applies the model to the evaluation of counter-cyclical monetary policy, a comparison of fiscal and monetary policy responses to economic shocks, and which extends the model to a multi-sector context.