A Near-Rational Model of the Business Cycle, with Wage and Price Inertia

George A. Akerlof · Janet L. Yellen

894 citations0/0 files storedThe Quarterly Journal of Economics

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

This paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects. The individual loss to agents with inertial price-wage behavior is second-order in terms of the parameter describing the shock, while the effect on real economic variables is first-order. Thus, significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses.

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