Knowledge that Transforms

This thesis explores the role of inflationary expectations in the dynamics of a general equilibrium, macroeconomic system.The analysis attempts to synthesize and extend the monetary models of Philip Cagan, Lloyd Metzler, and Don Patinkin, and dermine the stability properties of such extended models.Chapter 1 traces the history of the importance of inflationary expectations in the works of macro-economists.Although long recognized as important by the "monetarists," especially Irving Fisher, the importance of price expectations is now readily acknowledged by the "Keynesian" School of macro-economists.Chapter 2 examines the dynamics and properties of the Cagan model in detail, carefully indicating the assumptions which will later be relaxed in order to treat more general models.A critical examination of the role of adaptive expectations of the price level is presented in this chapter.Chapter 3 rigorously details the comparative statics of a Keynesian model by analyzing equilibrium in both the "asset" and "commodity"market as a "stock" and "flow" equilibrium.The following chapter discusses the dynamic adjustment of such a Keynesian model and the role of inflationary expectations is determined to be a key aspect of the determination of price behavior in the commodity market.Chapter 5 synthesizes the dynamic adjustment mechanism developed earlier into a full Keynesian model with both fixed and endogenous real income and a Fisherian, classical model of economic adjustment.The stability conditions of these general models are compared to those of the simple Cagan model discussed in Chapter 2.Chapter 6 examines the properties of proportional monetary policy in the context of the models developed in the previous chapter.Computer simulations of these policies are provided.In particular, it is shown that counter-cyclical monetary policy on the money rate of interest is the most effective proportional policy for damping the economy to equilibrium.The final, seventh chapter explains why the above policy is tantamount to the stabilization of a broader monetary aggregate in an economy consisting of a competitive, unregulated banking industry.The last chapter also extend the Keynesian system to allow for both a "long" and "short" interest rate and hence allows for a "lag" in the effect of monetary policy on the real economy.