An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis

We ask whether relations of the IS-LM type can sensibly be used for the aggregate demand portion of a dynamic optimizing general equilibrium model intended for analysis of issues regarding monetary policy and cyclical fluctuations. The main result is that only one change-the addition of a term regar...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 1999-08, Vol.31 (3), p.296-316
Main Authors: Mccallum, Bennett T., Nelson, Edward
Format: Article
Language:English
Subjects:
Aggregate demand
Aggregate supply
Analysis
Bank credit
Business cycles
Capital investments
Capital stock
Consumption
Costs
Credit
Criticism and interpretation
Cyclical analysis
Economic fluctuations
Economic models
Economic theory
Interest rates
Investments
Macroeconomic modeling
Macroeconomics
Mathematical economics
Modeling
Monetary policy
Nominal interest rates
Price levels
Prices
Studies
Textbooks
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Summary:We ask whether relations of the IS-LM type can sensibly be used for the aggregate demand portion of a dynamic optimizing general equilibrium model intended for analysis of issues regarding monetary policy and cyclical fluctuations. The main result is that only one change-the addition of a term regarding expected future income-is needed to make the IS function match a fully optimizing model, whereas no changes are needed for the LM function. This modification leads to a dynamic, forward-looking model of aggregate demand that is tractable and usable with a wide variety of aggregate supply specifications. Theoretical applications concerning price level determinacy and gradual price adjustment are included.
ISSN:0022-2879
1538-4616
DOI:10.2307/2601113