Rescuing the LM Curve (and the Money Market) in a Modern Macro Course

Roberto Tamborini

Chapter 4 in Macroeconomic Theory and Macroeconomic Pedagogy, 2009, pp 76-99 from Palgrave Macmillan

Abstract: Abstract The diffusion of direct control of the interest rate among central banks, and the parallel development of consensus on the so-called ‘New Neoclassical Synthesis’ blending New Classical and New Keynesian insights (Goodfriend and King, 1997; Blanchard, 2000; Woodford, 2003), have paved the way for the idea that macro-modelling can benefit greatly if it starts directly from the ‘fundamental three equations’ consisting of aggregate demand (IS), aggregate supply (AS) and a Taylor rule (TR) representative of interest-rate-based monetary policy. Taylor (2000), Romer (2000), Allsopp and Vines (2000), Carlin and Soskice (2004) provide examples of introductory-level treatments. Aside from the theoretical innovations in the aggregate demand and supply functions (which can be introduced at higher levels of sophistication), the main difference between this new workhorse and the one on duty to date (generally known as IS-AS-LM) is that the TR replaces the LM function as a means to determine the nominal interest rate and to link the monetary block with the real block of the economy.

Keywords: Interest Rate; Monetary Policy; Aggregate Demand; Money Demand; Nominal Interest Rate (search for similar items in EconPapers)
Date: 2009
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Persistent link: https://EconPapers.repec.org/RePEc:pal:palchp:978-0-230-29166-9_5

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DOI: 10.1007/978-0-230-29166-9_5

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