Keynesian Monetary Growth Under Adaptive Expectations

In this chapter¹ we shall reconsider Sargent's (1987) dynamic analysis of a Keynesian model with adaptive expectations. This analysis intends² to formalize the hypotheses advanced by Milton Friedman in his 1968 AEA presidential address, here for the case of adaptive expectations in an IS-LM growth context with an explicit wage-price sector, that is, for an integrated macromodel, which attempts to be a complete and consistent one.³ In comparison to the many reduced-form models that have been used in the literature for this task (see our Chap. 5 for an example), this can be characterized as an ambitious analytical target, since it will lead to a nonlinear dynamical model which — though well-known in all of its components — is difficult to analyze and which has thus not yet received a thorough and detailed treatment in the literature. Our findings will be that this type of model will not give rise to Friedmanian conclusions in general, but can at least equally well be used to demonstrate alternative views on the working of a capitalist economy.

One important result of our analysis of this integrated approach toward Keynesian monetary growth dynamics will be that one of its conventional building blocks — the strict form of the marginal productivity theory of real wages — should be dismissed from such a model. We shall see that this equilibrium theory of the price level (where prices react so to speak with infinite speed) can come into conflict with the economic viability of such a model of monetary growth under certain circumstances. Indeed, in criticizing the classical theory of employment, Keynes (1936, pp. 5 ff.) should not only have proposed to dismiss the Classical postulate no. 2 from a proper approach toward temporary equilibrium (and the trade cycle), but also the above Classical postulate no. 1. This will be demonstrated in Sect. 6.5 of this chapter and will be further considered in the next chapter, implying that the Sargent model must be modified as far as its treatment of the wage-price sector is concerned to make it an economically complete and consistent Keynesian macromodel of monetary growth.