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A Contribution to the Theory of Business Cycles

D. Foley
Journal / Anthology

Quarterly Journal of Economics
Year: 1992
Issue: August
Page range: 1071-1088

An economy consisting of identical perfectly competitive firms with real liquidity costs and a one-period production lag has a locally unstable stationary equilibrium with complex eigenvalues for a wide range of parameters. Monetary policy aimed at stabilizing real balances can support nonstationary equilibrium paths that converge to a limit cycle, which has Keynesian features. The First Welfare Theorem does not hold because the price level appears in the production function through liquidity costs, so that production has a positive externality.

*Business and Economics

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