The Cost Of Real Money

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However, with the LM curve moving to bring the economy to full employment, it seems impossible, in this case, to have sustained price rises (i.e. inflation) as the monetary side seems to close off the story entirely. One could subsequently argue that, as real wages (w/p) declined in the process, then workers would try to bid their money wages back up and thus regenerate the gap. However, recall that from the four-quadrant IS-LM diagram (our earlier Figure 4), when IS-LM centers on the full employment output level so that Y* = YF, then the labor market clears and thus there are apparently no inherent dynamics to imply a rise in wages. If anything, a Pigou Effect arising from the fall in real money balances ought to push the IS curve to the left and actually generate unemployment so the implied dynamic might actually be a fall in money wages (of course, in the process of the original adjustment, IS and LM could move concurrently to the left and land at YF together, but then we are back to a full-employment centered equilibrium). In short, in an IS-LM context, we can obtain price rises but, at least within the confines of the model, we cannot obtain continuous inflation unless aggregate demand rises again for some reason - and there is no apparent reason why it will do so.
The problem, of course, returns to the old issue of what happens in that mysterious labor market which was so murky in the Hicks-Modigliani IS-LM world. The Keynes-Smithies story has workers bargaining for
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