ABSTRACT
This chapter is actually one continuous argument, although the four sections can be read separately. The first develops the point that the critique of interventionist policy, especially the natural rate hypothesis, depends on the relation between changes in the money supply and the resulting effects on the real variables of the economy. This doctrine in turn rests on the ‘crowding out’ critique of fiscal policy, which is the subject of the next section, where it is shown that the conservative case is based on an incoherent concept of wealth and ‘wealth effects’. Then, in the third section, the relationship between real and monetary phenomena in neoclassical theory is explored, and it is shown, first, that the ‘real balance effect’ overcomes the problem of the ‘invalid dichotomy-it provides a coherent connecting mechanism-but, second, that it introduces a host of new problems, which are explored in connection with an examination of the basic model of mainstream macroeconomics. Finally, the last section examines Friedman’s work, which rests largely on the mainstream model but without the real balance effect. His work therefore contains the invalid dichotomy and a number of other problems as well. The conclusion is that neither monetarists nor mainstream economists have a valid theory of the relationship between the monetary and the real aspects of the economy.
