Inside and Outside Money, Gains to Trade, and IS-LM
CFDP Revision Date
We build a one-period general equilibrium model with money. Equilibrium exists, and ﬁat money has positive value, as long as the ratio of outside money to inside money is less than the gains to trade available at autarky. We show that the nominal eﬀects of government ﬁscal and monetary policy can be completely described by a diagram identical in form to the IS-LM curves introduced by Hicks to describe Keynes’ general theory. IS-LM analysis is thus not incompatible with full market clearing, multiple commodities, and heterogeneous households. We show that as the government deﬁcit approaches a ﬁnite threshold, hyperinflation sets in (prices converge to inﬁnity and real trade collapses). If the government surplus is too large, the economy enters a liquidity trap in which nominal GNP sinks and monetary policy is ineﬀectual.
Dubey, Pradeep and Geanakoplos, John, "Inside and Outside Money, Gains to Trade, and IS-LM" (2000). Cowles Foundation Discussion Papers. 1508.