Money and the Transmission Mechanism in the Optimizing IS-LM Specification

Abstract:     
This Paper discusses criticisms of the IS-LM framework in the macroeconomic literature of the last 40 years, and how the modern optimizing version of IS-LM addresses those criticisms. It is argued that models that include the optimizing IS-LM specification are legitimate vehicles for dynamic analysis: The evolution of nominal wages and prices is treated endogenously, and there is full recognition of the intertemporal nature of households' saving decisions. The optimizing version of IS-LM analysis remains vulnerable, however, to the monetarist critique: By recognizing an insufficient number of distinct assets, the IS-LM framework tends to understate the value of money as an indicator for monetary policy.

Number of Pages in PDF File: 49

Keywords: Money, monetary policy, optimizing IS-LM specification, transmission mechanism

JEL Classification: E52, E58

working papers series