Is Lm Model A Fundamental Tool?

872 WordsMar 23, 20174 Pages
Keynesian Macroeconomics without the LM Curve David Romer For macroeconomics education the IS-LM model is considered as a fundamental tool. IS-LM is a basic concept that is constructed to analyze the relationships of real output and interest rates in the goods market and the money market. David Romer did not accept the practice of IS-LM as a basic learning tool. Romer made a framework for the particular flaws of the IS-LM model and replaced it with another one that focuses some limitations with the model. Romer focused that the simple IS-LM model has some limitations. Firstly, it only assumes a fixed price level which does not analyze inflation. Romer certifies this model suitable for the 1950 's and 60 's. At that time inflation was not…show more content…
Monetary policy was explained through the real interest rate. As explaining through real interest rate is more realistic than explaining through nominal interest rate. And it makes the model less complex. The LM curve is more complicated than a real interest rate. When there is high inflation, it focused on inflation first, and it raises real interest rate so that the output decreases and inflation diminishes. And in time of low inflation instead of focusing on inflation, it lowers real interest rate to increase output. The aggregate demand curve is a relationship between inflation and output. The real rate is determined by inflation and output is determined by IS curve. In this model two events do not happen at the same time. So, at first, inflation occurs and thus the real interest rate is determined, and eventually output is determined by the real interest rate. As the movement of output from its usual state is a result of change in inflation which provokes central bank to shift the real interest rate, which shift output back to previous state. The Money Market In the new model, the correct concept of money is specific. It focused on how adjustment in expected inflation influences the central banks adjustment of the money supply because of the real interest rule though it does not have any other impact on aggregate demand. The Open Economy It is better to create a

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