ABSTRACT
The key proposition of monetarism is that, if markets are perfectly flexible, monetary changes do not affect the volume of output and employment; they affect only the level of prices. Monetarist theology is crucially dependent on the real-balance effect argument. In the version developed by Don Patinkin, the existence of unemployed resources exerts a downward pressure on wages and prices. By contrast with the Free-Market “secular” explanation, the Monetarist “theological” explanation refuses to admit the possibility of any reduction in the volume of output and employment. The monetarists are quite right to argue that, in flexible markets, an increase in the desire to hoard will have a powerful effect on the level of prices. They are also entitled to criticise Keynes for having failed to take this into account. There is, however, a fallacy in the monetarist argument, and it has its origin in Patinkin’s explanation of the “real-balance effect”.
