A Short Period Sraffa-Keynes Model for the Evaluation of Monetary Policy

Abstract

ABSTRACT This paper develops a short period, one sector, Sraffa-Keynes model that can be used for the evaluation of various recommendations outlined in the Post Keynesian monetary policy literature. The model is characterised by the principle of effective demand, Sraffa or target-return pricing (which integrates the determination of key distributive variables and allows for short run cyclical variation in prices), conflict inflation, endogenous money and a basic approach to monetary policy in the Smithin–Wray tradition of fixing the policy rate to achieve low or specified rates of unemployment. The model is calibrated to the Australian economy and subjected to two standard macroeconomic shocks, a demand shock and a cost shock. After each shock, the economy returns to long period equilibrium characterised by the achievement of the target rate of return, desired capacity utilisation and Sraffian prices of production. Active monetary policy that targets employment, reduces the depth and duration of recessions in this model compared to a ‘park-it’ approach but at the cost of increased volatility in income distribution. Flexible prices (where firms respond to the additional costs of running the capital stock at other than full capacity) are shown to have similar effects to monetary policy.