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

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  • Bennett T. McCallum
  • Edward Nelson

Abstract

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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5875.

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Date of creation: Jan 1997
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Publication status: published as Journal of Money, Credit, and Banking, Vol. 31, no. 3, part 1, pp. 296-316, August 1999
Handle: RePEc:nbr:nberwo:5875

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