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

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  • McCallum, Bennett T
  • Nelson, Edward

Abstract

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.

Suggested Citation

  • McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
    • Handle: RePEc:mcb:jmoncb:v:31:y:1999:i:3:p:296-316
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    More about this item

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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