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New Keynesian DSGE Models and the IS-LM Paradigm

  • Ulrich Frische

    ()

    (University of Hamburg)

  • Ingrid Größl

    ()

    (University of Hamburg)

New Keynesian DSGE models propose a dynamic and expectational version of the old IS-LM paradigm. Acknowledging that the Taylor rule as a substitute for the LM-curve has its merits we show that standard DSGE models do not model how the central bank achieves its targets. In filling this gap we make evident that models neglecting a store-of-value function of money but still assuming a Taylor rule are inconsistent. Our major point concerns the-so called new Keynesian IS-curve. We prove that DSGE models which typically rest on the assumption of representative agents are unable to derive the IS-curve. This implies that these models lack the capability to analyse the role of savings as a a gap in aggregate demand. By assuming overlapping generations we make evident how this shortcoming can be avoided. We also show how OLG models add a richer dynamics to the standard DSGE approach.

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Paper provided by IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute in its series IMK Working Paper with number 1-2010.

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Length: 33 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:imk:wpaper:1-2010
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  1. Jordi Galí & J. David López-Salido, 2003. "Understanding the Effects of Government Spending on Consumption," Working Papers 73, Barcelona Graduate School of Economics.
  2. Jordi Galí & Tommaso Monacelli, 2005. "Optimal Monetary and Fiscal Policy in a Currency Union," Working Papers 240, Barcelona Graduate School of Economics.
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  4. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
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  6. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  7. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
  8. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  9. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  10. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
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  12. Linnemann, Ludger & Schabert, Andreas, 2003. " Fiscal Policy in the New Neoclassical Synthesis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(6), pages 911-29, December.
  13. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
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