ABSTRACT Some years ago (before the outbreak of the financial crisis) most of the major central banks—in general— shifted to interest rate control. But does this fact render obsolete the ISLM scheme, which is apparently tied to money supply control? And isn’t it necessary to find a solid basis for interest rate control instead of just following ad hoc policy functions? This paper is a sensible approach based on the important pioneering work of William Poole , which shows firstly that the static ISLM framework can be further developed for the case of interest rate control and that secondly the current financial crisis and especially the policy reactions of central banks can be explained. Thirdly also the optimization behavior of central banks can be adequately represented in the dynamic version of our model framework. Especially in times of financial and economic crises (when central banks possibly switch their monetary policy instruments back to quantitative easing), it seems to be very helpful to be able to display both interest rate control and money supply control within one single model framework. Our analysis will show that retaining the LM curve is both practical and indispensable for didactic and analytical reasons.
Cite this paper
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