An Optimizing Is-Lm Specification for Monetary Policy and Business Cycle Analysis

54 Pages Posted: 13 Jul 2000 Last revised: 4 Oct 2010

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Edward Nelson

Board of Governors of the Federal Reserve System

Date Written: January 1997

Abstract

This paper asks whether relations of the IS-LM type can sensibly be used for the aggregate demand portion of a dynamic optimizing general equilibrium model intended for analysis of issues regarding monetary policy and cyclical fluctuations. The main result is that only one change -- the addition of a term regarding expected future income -- is needed to make the IS function match a fully optimizing model, whereas no changes are needed for the LM function. This modification imparts a dynamic, forward-looking aspect to saving behavior and leads to a model of aggregate demand that is tractable and usable with a wide variety of aggregate supply specifications. Theoretical applications concerning price level determinacy and inflation persistence are included.

Suggested Citation

McCallum, Bennett T. and Nelson, Edward, An Optimizing Is-Lm Specification for Monetary Policy and Business Cycle Analysis (January 1997). NBER Working Paper No. w5875. Available at SSRN: https://ssrn.com/abstract=225659

Bennett T. McCallum (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

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Edward Nelson

Board of Governors of the Federal Reserve System ( email )

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