In thinking about an entire economy, one of the critical research choices is how to relate the way that one models entire economies to the way that one models individual markets. One approach has each of these research activities proceeding independently of the other, with industry studies focusing on individual firm and household data and economy studies focusing on aggregate data. An alternative approach attempts to develop a consistent way of addressing both classes of issues. I have been part of this second group, working in what has been called the micro foundations of macro. This lecture will continue in this mode.

There are three broad categories of approaches for modeling purchasing power. Some models focus on income (with or without a role for interest rates), some models focus on money (again, with or without a role for interest rates), and some models focus on credit. It is hard to use a model that addresses all three sources at once.

I will proceed by considering the Hicksian ISLM model, and then turning to explicit-time models. In the first lecture, I contrasted a single explicit-time model with atemporal models to illustrate the importance of paying more attention to time. For this lecture, I use several explicit-time models, each with some of the properties we would like such a model to have.

Short run and long run

As in the first lecture, I want to start with the contrast between the short run and the long run. Maiinvaud draws this distinction as follows: