ABSTRACT
The first modification of the neoclassical model is presented in this chapter. To begin we introduce the very realistic assumption that nominal wages are fixed, at least for a period of time. The ramifications of this change in the model are developed in the context of the aggregate supply and demand model. As with the neoclassical model, we perform a comparative statics exercise in which the monetary authority changes the money supply and we trace out the effects of this action on the economic aggregates in the model. The model is then made slightly more complete, and issues associated with sticky wages and the natural rate hypothesis are discussed. We introduce the concept of rational expectations and the first “overlapping” model, and show that the Keynesian model has important implications for the conduct of monetary policy.
