An Optimizing IS-LM Framework with Endogenous Investment.pdf.pdf' (418.01 kB)
An Optimizing IS-LM Framework with Endogenous Investment
journal contribution
posted on 2007-10-01, 00:00 authored by Miguel Casares, Bennett T. McCallumDynamic optimizing models with an IS-LM-type structure and slow price adjustments have
been used for much recent monetary policy analysis, but usually with capital and investment treated
as exogenous—a significant restriction. This paper demonstrates that investment decisions can be
endogenized without undue complexity in such models and that these can be calibrated to provide
reasonably realistic dynamic behavior. It is necessary, however, to include capital adjustment costs;
models with no adjustment costs match cyclical data very poorly. Indeed, their match is considerably
poorer than models with constant capital. The paper also finds that the preferred adjustment-cost
specification is not close to quadratic.