Comments on McCallum

Abstract

Professor McCallum's remarks seem to have little bearing on what I have to say. I write: In particular I am questioning the view that prices must continue to change as long as some agent is quantity (p. 288). However, that is the view of McCallum's equation (6). Moreover, I was concerned to take quantity constraints seriously, i.e. to incorporate them into formal theorizing. Thus, when there is involuntary unemployment agents are constrained by more than the budget. It then follows from maximization under constraint that the demand for goods cannot be independent of the quantity constraint on the sale of labour. Moreover, unless profits are always zero the quantity constraint on firms, (if it bites) must be reflected in the budget. However, McCallum's equation (1) ignores this. I was also concerned to make supply decisions depend on forecasts of quantity constraints and on conjectures of the latter's responsiveness to prices. This too finds no place in McCallum. I did not claim that a model that ignores all these points would leave room for government policy. None the less, McCallum's remarks are instructive because they make it easier to see what the argument is about. It is not, as his note suggests, about rational expectations, nor does it turn on the distinction between sustained policy and isolated government action (p. 302). It may help economic understanding to restate McCallum's ineffectiveness proposition. For this purpose we can abstract from the stochastic setting since it is not essential. So let Pt be the Walrasian equilibrium price at t. It is correctly predicted at t 1. From McCallum's equation (1) we have