The IS-LM-BB: a model of 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.