In an important article in this Review, William Brainard and James Tobin have emphasized the role played by the wealth constraint in systems of asset demand equations. The wealth constraint gives rise to consistency conditions which must be satisfied by the demand functions when such a system is specified and estimated. As Brainard and Tobin caution, care must be taken to ensure that unrealistic coefficients are not inadvertently imposed on omitted equations by failure to recognize the consistency conditions.' Noting that the wealth constraint applies out of, as well as in, portfolio equilibrium, Brainard and Tobin focus attention on systems in which actual and desired stocks of assets differ. They specify a multivariate stock adjustment model wherein the desired change in holdings of any asset depends in general upon all asset stock disequilibria; the existence of such stock disequilibria can be implicitly rationalized on the basis of costs of adjustment which impinge on the rate of change of at least some assets. In this framework they show that the stock adjustment coefficients must also satisfy certain consistency conditions to ensure that the wealth constraint is satisfied. An important feature of their analysis is that the total change in wealth (savings plus capital gains) is treated as exogenous to the financial sector, and the asset flow demands described above are conditional upon the exogenously given change in wealth. This strategy of separating the portfolio balance decision from the consumption-saving decision is one that Tobin has explicitly used and justified in his 1969 article (especially pp. 15-16), and is one that has been widely and effectively used in modern macroeconometric models. The central argument of the present paper is that this of flow-allocation and stock-allocation decisions is not legitimate in the presence of adjustment costs attached to changing the level of individual asset holdings. The existence of adjustment costs means that there is no portfolio balance problem per se (in the sense of allocation of a given level of wealth), but rather a (longer run) problem of determining an optimal time path for each asset and for the level of consumption. Thus a natural extension of the Brainard-Tobin model is to treat saving and portfolio decisions in an integrated fashion.2 Note that the Brainard-Tobin model is perfectly consistent with any model of savings behavior and hence no logical con*Queen's University, and Cowles Foundation for Research in Economics, Yale University. I am grateful to Adrian Pagan, Gordon Sparks, and James Tobin for helpful discussions, and especially to Gary Smith who, as well as patiently discussing many of the issues, provided detailed comments on earlier drafts of this paper. This research was partially supported by a National Science Foundation grant to the Cowles Foundation and by a Canada Council grant to the author. Remaining mistakes and opinions are my own. I This also has implications for the common practice in macro-economic models of leaving the bond market as implicit. Care must be taken to ensure that silly behavior is not inadvertently attributed to bondholders. William Silber, Tobin, and Alan Blinder and Robert Solow have initiated research which reintroduces the bond market into macroeconomic models. 21t appears to be a fairly general result that the existence of adjustment costs leads to integrated behavior. M. Ishaq Nadiri and Sherwin Rosen have established a similar result for the theory of the firm, and Robin Mukherjee and Edward Zabel have recently shown that the separation theorem prominent in the finance literature on the mean-variance approach to optimal consumption-portfolio behavior fails to hold when transactions costs are introduced. In my 1975 paper (Appendix), I have argued that the integration of saving and portfolio balance decisions also applies in continuous-time models, even though such models are characterized by separate stock and flow budget constraints.

Originating with James Tobin's initial treatment of money as a second asset in the Solow one-sector growth model, the subject of money and growth has received a great deal of attention in the recent literature. Tobin's emphasis on portfolio balance to determine the equilibrium of the model provides a useful framework for the discussion of the development of two opposing schools of thought among recent writers on the subject of money and growth. The neoclassical approach follows Tobin in his emphasis on portfolio balance and includes contributions by Miguel Sidrauski and Harry Johnson, among others. A cogent and comprehensive statement of the neoclassical viewpoint can be found in the excellent survey by David Levhari and Don Patinkin. The second approach the Keynes-Wicksell approach --as expounded by Jerome Stein in particular, and also including contributions by Hugh Rose and Keizo Nagatani, faults the neoclassical model on two basic and related points. They are the implications of the model for the dynamics of price change, and the lack of independent savings and investment decisions. The neoclassical approach is characterized by the assumption that desired per capita real balances are always held-prices must adjust instantaneously to assure portfolio balance. A given rate of expansion of the nominal money stock combined with the exogenously given rate of population growth serves to determine the equilibrium rate of inflation consistent with asset equilibrium. The division of assets between money and physical capital is thereby determined, and there need be no specification of an independent investment function all physical savings are instantaneously channelled into capital accumulation, and the desired capital stock is always held.' The long-run properties of the neoclassical model allow for the coexistence of nonzero steady-state inflation and goods market equilibrium by specifying that excess demand for goods causes a departure from the steady-state rate of inflation, but is not a necessary condition for a nonzero inflation rate at any point in time. It is contended that, in a dynamic world, there are two forces operating to drive the price level-excess demand for goods and inflationary expectations. In steady state, excess demand is zero; actual inflation equals expected inflation, not necessarily zero; and the possibility of nonzero steady* Queen's University. This paper was written while I was a graduate student at the University of Chicago. My understanding of the issues has been greatly improved by many discussions with Rudiger Dornbusch, Stanley Fischer, and Michael Mussa. I also wish to thank members of workshops at the University of Chicago, University of Rochester, and York University, and to participants in the Chicago Symposium on Trade, Growth, and the Balance of Payments (University of Chicago, December 1970) for helpful comments on an earlier version of this paper. Jerome Stein, George Borts, and an anonymous referee provided very useful comments for which I am most grateful. Of course, I am responsible for any remaining errors. Financial support from the Canada Council is gratefully acknowledged. I A puzzling result of Tobin's initial treatment is that the introduction of money into the barter model lowered the capital intensity and output per capita. I have recently tried to analyze this seemingly paradoxical result elsewhere (see Purvis).