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Macroeconomics without the LM: A Post-Keynesian Perspective

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Author Info
Thomas I Palley
Abstract

David Romer (2000) provides an alternative model to the AS/AD and IS/LM models that abandons the LM schedule by having the short-term interest rate set by the central bank. His framework acknowledges the critical role of the central bank in determining short-term interest rates, which moves mainstream macroeconomics closer to Post Keynesian monetary theory.

The current paper presents a Post Keynesian construction of macroeconomics without an LM schedule. Rather than describing the financial sector in terms of an exogenously determined interest rate set by the central bank, the model unpacks financial markets by fully specifying a banking sector. The key analytic feature of the Post Keynesian approach is to replace the money market with the loan market. That makes transparent the macroeconomic significance of the loan market and bank behavior, and generates an endogenous money supply driven by bank lending. If banks become more optimistic over the cycle and lower their interest rate mark-up, that increases the likelihood of instability.

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File URL: http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_151-200/WP179.pdf
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Paper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp179.

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Date of creation: 2008
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Handle: RePEc:uma:periwp:wp179

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Related research
Keywords: bank lending; credit; endogenous money; loan market;

Find related papers by JEL classification:
E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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This page was last updated on 2009-11-21.

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