Keynesian economics without the LM and IS curves: a dynamic generalization of the Taylor-Romer model
John Taylor and David Romer champion an approach to teaching undergraduate macroeconomics that dispenses with the LM half of the IS-LM model and replaces it with a rule for setting the interest rate as a function of inflation and the output gap - i.e., a Taylor rule. But> the IS curve is problematic, too. It is consistent with the permanent-income hypothesis only when the interest rate that enters the IS equation is a long-term rate - not the short-term rate controlled by the monetary authority. This article shows how the Taylor-Romer framework can be readily modified to eliminate this maturity mismatch. The modified model is a dynamic system in output and inflation, with a unique stable path that behaves very much like Taylor and Romer's aggregate demand (AD) schedule. Many - but not all - of the original Taylor-Romer model’s predictions carry over to the new framework. It helps bridge the gap between the Taylor-Romer analysis and the more sophisticated models taught in graduate-level courses.
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- John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
- Dale W. Henderson & Warwick J. McKibbin, 1993.
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International Finance Discussion Papers
458, Board of Governors of the Federal Reserve System (U.S.).
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- William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
- Robert G. King, 1993. "Will the New Keynesian Macroeconomics Resurrect the IS-LM Model?," Journal of Economic Perspectives, American Economic Association, vol. 7(1), pages 67-82, Winter.
- Athanasios Orphanides, 2002.
"Monetary-Policy Rules and the Great Inflation,"
American Economic Review,
American Economic Association, vol. 92(2), pages 115-120, May.
- David H. Romer, 2000.
"Keynesian Macroeconomics without the LM Curve,"
Journal of Economic Perspectives,
American Economic Association, vol. 14(2), pages 149-169, Spring.
- Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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