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Unformatted text preview: Lecture 19 Can We Replace IS-LM? Readings: Hubbard, OBrien, and Rafferty (2011)-Chapter 9 & 10 Recently, textbooks have been overhauling themselves to try and come up with a new way to teach macroeconomics in general. Here we are going to cover the IS-MP model using two chapters from a new book by Hubbard, OBrien, and Rafferty (2011) that we will discuss as a replacement to the IS-LM model. I would also like you to compare this model to the IS-PC-MR model we covered earlier in the semester. At this point, the material here is in the testing phase, so you will be asked to give some feedback on the material at the end of the week. I know this is a busy time, but economists have been struggling with an update to IS-LM for 30 years and I think were on the verge of getting around to it. Section 19.1 IS Curve To begin, the IS-MP model is similar in spirit to the IS/PC/MR we have discussed already. The IS-MP model represents aggregate demand that shows the determinants of aggregate expenditures for a given inflation rate by analyzing the market for goods and services and financial markets(Hubbard, OBrien, and Rafferty, 2011). 1 The IS curve, represents equilibrium in the goods market at a given real interest rate. The IS curve is built here by first examining aggregate expenditures as the combination of consumption ( C ), investment ( I ), government spending ( G ), and net exports ( NX ). Aggregate expenditures may be greater than, less than, or equal to actual output. Most of the action is explained here using inventories, which if you remember are a small part of investment ( I ). AE = C + I + G + NX (19.1) If AE > Y then the economy is producing too little, and output should rise in the future. Firms were 1 if you have trouble recalling the IS-LM model, you can find it in the Appendix of Chapter 9 in Hubbard, OBrien, and Rafferty (2011). Even in a book replacing the IS-LM, they cant seem to get rid of it. 1 planning a level of inventory investment, and planned investment is too low since demand ( AE ) was higher than expected. Likewise, if AE < Y too much is being produced, and firms should cut back on future production as their unsold inventories accumulate. Our equilibrium is found where Y = AE and planned investment equals actual investment. Hubbard, OBrien, and Rafferty (2011) then goes on to explain that consumption is a function of output, like you might have learned in an earlier course. Here we will depart from these chapters for a moment, and presume that C = C + mpc Y + r rather than C = mpc Y . 2 The authors later explain that C , I , and NX are all related to real interest rates, so well put it right up front in our consumption function....
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- Spring '11