Real Balances, the Inflation Tax, and Sargent's Consumption Function

Sargent's (1987a) textbook treatment of static equilibrium theory argues that if expected inflation is positive, real balance effects are perverse, and the traditional argument, whereby flexible wages guarantee full employment, is incorrect. This paper argues that Sargent misrepresents traditional static theory by using as a model of consumption an equilibrium condition from the monetary growth literature. perverse real balance effects appear when this equilibrium condition is treated as a behavioral relationship. A well-specified optimizing model is presented which suggests the proper treatment of real balance effects and expected inflation in static equilibrium.

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	Cushing, Matthew J Professor of Economics Expertise: Monetary Policy Public Finance Econometrics Economics CBA 352 P.O. Box 880489 University of Nebraska-Lincoln Lincoln, NE 68588-0489, USA Phone: (402) 472-2323 Fax: (402) 472-9700 mcushing1@unl.edu	Cushing, Matthew J	Economics