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New Keynesian DSGE Models and the IS-LM Paradigm

Ulrich Fritsche () and Ingrid Größl ()
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Ingrid Größl: University of Hamburg

No 1-2010, IMK Working Paper from IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute

Abstract: 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.

New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mic
Date: 2010
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