AbstractIn this paper we present a small Keynesian macro‐economic model in which wage‐price determination is linked to the working of goods and money markets. By explicitly treating the Keynes effect we derive a general expression for the employment‐money supply elasticity, and draw the IS‐LM loci in the employment‐interest rate spaceOur empirical specification allows for short‐run disequilibrium dynamic adjustments around the static long‐run relations predicted by the theoretical model. By careful use of our specification search strategy we obtain a statistically sound econometric model, which exhibits sensible long‐run properties. A remarkable finding implied by our estimates is that equilibrium unemployment is negatively affected by both money supply and