Price Flexibility and Output Stability An Old Keynesian view with incredulity when Keynesians mention them However if these adjustments do not occur instantaneously but take real time, then Keynesian situations of excess supply do occur. They occur even if prices and interest rates are falling at the same time. The consequence is that the quantity adjustments of the multiplier process start working counter to the possible equilibrating effects of interest rate and price reductions In standard Walrasian/Arrow-Debreu theory, perfect flexibility of all wages and prices, present and future, would maintain full employment equilibrium Short of that, an old question of macroeconomic theory is whether, given current nominal wages and prices, changes in future money wages and prices that is, in nominal interest rates-could do the job In old classical macroeconomics, interest rates are the equilibrators of both capital markets and goods markets. Their adjustment is crucial to the Say's Law story, which dismisses as vulgar superficiality notions that an economy could suffer from shortfalls in demand for commodities in aggregate Market interest rates keep investment equal to saving at their full-employment levels-and therefore keep aggregate demand equal to full employment output-even if nominal product prices and wages stay put. Indeed classical doctrine is that the real equilibrium of the economy is independent of nominal prices, as if it were the outcome of moneyless frictionless multilateral Walrasian barter Can interest rates do the job? The Keynesian insight is that the institution ally fixed nominal interest rate on currency, generally zero, limits the adjust- ment of nominal interest rates on non-money assets and imparts to them some stickiness even when they are above zero. As a result, after an aggregate demand shock they may not fall automatically to levels low enough to induce sufficient investment to absorb full employment saving. As a result, aggregate demand-consumption plus investment-will fall short of full employment supply The case for significant non-zero interest elasticity of money demand is simply that the opportunity costs of holding money fall as the interest rates available on non-money substitutes decline. As those rates approach the interest paid on money itself, zero at the lowest, the opportunity costs vanish. The interest rate on money sets the floor for other nominal market interest rates The familiar specific money demand models-transactions costs, risk aversion regressive interest rate expectations-all depend on the fixed nominal interest The interest-elasticity of money demand is a key parameter in macroeco- nomic theory. Three cases can be distinguished. One is a classical extreme, often associated with the quantity theory of money: the elasticity is zero. At the other extreme is the Keynesian liquidity trap market interest rates are so close to the foor that people are on the margin indifferent between money and Dudley Dillard (1988)calls this the"barter illusion"of classical economics