short-Run Dynamics in Models of Money and Growth

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).

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