Consumption Expenditures, Money Balances, and Government Debt

Pigou effects are wealth effects which make real consumption expenditures vary directly with real money balances and perhaps with real government debt as well.

Pigou effects restore the classical result that price and money-wage flexibility assures full employment in the face of the Keynesian liquidity traP and negative interest rate case exceptions.

The classical concept of the neutrality of money is not disturbed by simPle Pigou effects as long as the classical money demand function is retained, but it is invalidated by Pigou effects that incorporate real government debt.

Chapter 15 concluded that, if real money balances demanded vary inversely with the expected change in prices, neutrality of money is lost even without Pigou effects, since dynamic money supply disturbances will then affect equilibrium real money balances. Including even simple Pi9ou effects involves further qualifications. Dynamic money supply disturbances then affect equilibriums for real interest rate, real saving, real investment expenditures and real consumption expenditures.

Insofar as the monetarist propositions are concerned, Pigou effects contribute to the view of money supply disturbances as the principal source of price and employment problems and also to the performance of stable money supply growth. The implications of Pigou effects for the monetary versus fiscal policy issue are less clear. The simple Pigou effect makes monetary policies stronger relative to fiscal policies. However, with a Pigou effect including real government debt, the effect on the relative strength of monetary and fiscal policies depends on the strength of the various relationships involved in the model at large.

Whether Pigou effects should be included in models used for macroeconomic analyses and forecasting depends on their empirical strength. Economists often omit them from short-term analyses on the grounds that they are weak.