A Pure Theory of Aggregate Price Determination

Abstract

This article considers aggregate price determination related to the neutrality of money. When the true cost of living can be defined as a function of prices in an overlapping generations (OLG) model, the marginal cost of a firm depends solely on the current and future prices. Thus, the sequence of equilibrium price becomes independent of the quantity of money. Hence, money becomes non-neutral. However, when people hold the extraneous belief that prices increases proportionately with money, this belief becomes self-fulfilling as long as the increment of money and true cost of living are low enough to guarantee full employment.