ABSTRACT
This chapter begins by outlining the New Keynesian treatment of menu costs with particular reference to the use of such costs in providing an explanation for fluctuations in economic activity in the face of nominal demand shocks. It is argued that whilst there are undoubtedly costs of price adjustment, there are also costs of output adjustment, and it is not clear that firms would always willingly incur the output adjustment costs rather than price adjustment costs. The second and major argument of this chapter is that the New Keynesian explanation of fluctuations in economic activity is based on the assumption of exogenous money, whereas in an industrialized economy money is endogenously created within the private sector, and that the explanation of fluctuations would not survive a change of assumptions from exogenous to endogenous money. Shifts in nominal demand are modelled as akin to changes in the money stock, and hence if the analysis based on changes in the money stock is invalid then so is the analysis of nominal shocks.
