The LM Curve: A Not-So-Fond Farewell / Benjamin Friedman.

By:

Friedman, Benjamin

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w10123.Publication details: Cambridge, Mass. National Bureau of Economic Research 2003.Description: 1 online resource: illustrations (black and white)Subject(s):

E52 - Monetary Policy

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Abstract: One of the most significant changes in monetary economics in recent years has been the virtual disappearance of what was once a dominant focus on money, and in parallel the disappearance of the LM curve as part of the analytical framework that economists use to think about issues of monetary policy. Today's standard workhorse model consists of an aggregate demand (or IS) curve and an aggregate supply (or price setting) curve, with the system closed when appropriate by an equation that represents monetary policy by relating the nominal interest rate to variables like output and inflation, but typically not either the quantity or the growth rate of money. This change in the standard analytics is an understandable reflection of how most central banks now make monetary policy: by setting a short-term nominal interest rate, with little if any explicit role for money.' But the disappearance of the LM curve has also left two lacunae in how economists think about monetary policy. Without the LM curve it is more difficult to take into account how the functioning of the banking system, and with it the credit markets more generally, matter for monetary policy. Abandoning the role of money and the analytics of the LM curve also leaves open the underlying question of how the central bank manages to fix the chosen interest rate in the first place.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w10123 (Browse shelf(Opens below))	Not For Loan

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November 2003.

One of the most significant changes in monetary economics in recent years has been the virtual disappearance of what was once a dominant focus on money, and in parallel the disappearance of the LM curve as part of the analytical framework that economists use to think about issues of monetary policy. Today's standard workhorse model consists of an aggregate demand (or IS) curve and an aggregate supply (or price setting) curve, with the system closed when appropriate by an equation that represents monetary policy by relating the nominal interest rate to variables like output and inflation, but typically not either the quantity or the growth rate of money. This change in the standard analytics is an understandable reflection of how most central banks now make monetary policy: by setting a short-term nominal interest rate, with little if any explicit role for money.' But the disappearance of the LM curve has also left two lacunae in how economists think about monetary policy. Without the LM curve it is more difficult to take into account how the functioning of the banking system, and with it the credit markets more generally, matter for monetary policy. Abandoning the role of money and the analytics of the LM curve also leaves open the underlying question of how the central bank manages to fix the chosen interest rate in the first place.