The IS-LM-BB: A Model for Unconventional Monetary Policy

The Monetary policy of the United States has not been the same since the 2008-2009 international crisis. Following the crisis, given that the federal funds interest rate – the conventional monetary policy instrument – fell to almost zero, the Federal Reserve (FED) had to resort to two unconventional instruments: Firstly, an announcement on the future trajectory of the short-term interest rate. Secondly, direct intervention in the long-term bond market.  The objective of this article is to extend the IS-LM model devised by Hicks (1937), to incorporate American monetary policy innovations. This updated model, unlike IS-LM, takes into account that the FED administers the short-term interest rate, not monetary supply, which is endogenous. On the other hand, so as to address quantitative easing, a long-term bond market is added to the IS-LM —in which there only exists a short-term bond market— by resorting to Tobin (1981). This article shows that the old models and the old methods remain very useful in dealing with contemporary macroeconomic problems.

Keywords

Unconventional monetary policy, Liquidity trap, IS-LM model.

JEL Classification

E52, E58

‍