An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis
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NBER Working Paper No. 5875 (Also Reprint No. r2259)
Issued in March 2000
NBER Program(s): EFG ME
This paper asks 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 imparts a dynamic, forward-looking aspect to saving behavior and leads to a model of aggregate demand that is tractable and usable with a wide variety of aggregate supply specifications. Theoretical applications concerning price level determinacy and inflation persistence are included.
Published: Journal of Money, Credit, and Banking, Vol. 31, no. 3, part 1, pp. 296-316, August 1999
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