A simple framework for analyzing the macroeconomic effects of inside money

The majority of the New Keynesian DSGE literature assumes that the macroeconomic effects of monetary policy can be satisfactorily described by an interest rate rule without addressing the details of the money supply. We investigate whether this approach remains valid in the presence of inside money created by the banking system. To analyze this issue we present a framework based on the generalization of the IS and LM curves to dynamic general equilibrium models. We find that it is possible to implement a policy based on an interest rate rule even in the presence of inside money, although it requires a more complex toolkit of monetary policy implementation than it is assumed in models with only outside money. We also show that despite some current views, the existence of inside money does not invalidate the common macroeconomic wisdom that investments are linked to savings: both savings and financing matter in determining investments.