Econometrica: Nov, 1973, Volume 41, Issue 6

The Stability of Models of Money and Growth with Perfect Foresight

https://doi.org/0012-9682(197311)41:6<1043:TSOMOM>2.0.CO;2-C
p. 1043-1048

Neil Wallace, Thomas J. Sargent

It is often claimed that models of money and growth which assume perfect foresight are dynamically unstable. If the system is initially in a steady state with zero inflation, it is claimed that a once-and-for-all increase in the money supply will set off a process of ever-accelerating deflation. Here we set forth an alternative view according to which such an increase in the money supply produces a once-and-for-all increase in the price level that is just sufficient to keep the system at its steady state. Consequently, the system is stable, making it possible to perform meaningful comparative static experiments. Our view provides a way of reconciling traditional analysis with recent dynamic analyses.