real balance effect

real balance effect

or

Pigou effect

the mechanism by which a change in the real value of money balances leads to a change in AGGREGATE DEMAND. If prices are flexible in an economy, a decrease in prices, for example, will increase the real value of a household's cash holdings. The increase in a household's money wealth increases its PURCHASING POWER, thereby stimulating consumption. By contrast, a rise in prices will decrease the real value of a household's cash holdings and by reducing its purchasing power cause it to consume less. Since prices are most likely to fall during a recession, then the Pigou effect will serve partially to offset the fall in consumption associated with the recession. However, if the Pigou mechanism occurred at a point of full employment, then the increase in consumer demand associated with the increase in real money wealth could not be satisfied because the economy would already be operating at full capacity. Here, prices would rise until real money balances were restored to their original level.
References in periodicals archive ?
For example, and with respect to the real balance effect, also called the real wealth effect, the money wealth effect, and the Pigou effect, aggregate demand will be more elastic for any given change in the price level the more responsive is consumption spending to the resulting change in real wealth, ceteris paribus.
When the real balance effect of money growth is weakly dominated by the consumption effect and some conditions are satisfied, higher monetary growth lowers steady state capital, labor, real balances, consumption, and welfare.
Secondly, a nominal devaluation can decrease aggregate demand through the negative real balance effect due to a higher price level which in turn may decrease the level of output.
The Liquidity Trap, the Real Balance Effect, and the Friedman Rule.
In contrast, Polanyi recognized the real-world policy implications of the real balance effect.
This proportional relationship was, he believed, established through the operation of a real balance effect.
For Wicksell, then, the classical quantity theory implied money stock and price level proportionality achieved through real balance effects.
He includes a real balance effect in his story, and his interest rate theory is a loanable-funds theory, not a liquidity preference theory.
Many economists insist that the real balance effect holds only for outside money [Gurley and Shaw, 1960].
In particular, I derive a real balance effect that explicitly enters the IS relation within an optimizing general equilibrium framework of the new Keynesian type.
Second, the derivation of the real balance effect does not require nonseparability in the utility function.
Dornbusch [1973, 883] has argued that if such a real balance effect is not present, "then it might stand to reason that the effects of devaluation are negligible, not that there must be other powerful avenues through which it exerts its effects" (emphasis added).