Keynesian economics without the LM and IS curves: a dynamic generalization of the Taylor-Romer model

Evan Koenig

No 813, Working Papers from Federal Reserve Bank of Dallas

Abstract: 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.

Keywords: Economics - Study and teaching; Taylor's rule; Interest rates; Macroeconomics; Monetary policy (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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