The Invalidity of Walras' Law in Monetary Economies and the Resulting Money Price Determinacy

Abstract

In this paper I analyze the historical treatment of the problem of money price determinacy starting with Walras (1874) and Patinkin (1948) up to the latest results by Weil (1991) and Benassy (2007). I show then based on an extremely simple model that Walras’ Law does hold in a pure barter economy but not in a monetary economy, if money supply is modeled in a realistic way. As a consequence, in a monetary economy with N goods there are N independent market equilibrium conditions available to determine the N money prices of all goods. For many classes of models this equality of equations and unknown variables is sufficient to determine the money prices of goods unambiguously – even in the case of Ricardian economies, where money holdings are no net wealth.

Keywords: Walras Law, Price Determinacy, Neoclassical Dichotomy, Real-Balance Effect, Pigou Effect, Patinkin Controversy, Inside Money, Outside Money, Monetary Theory

JEL Classification: E50