Question

What is three equation model in economics?

Answer 1

Monetary Macroeconomics is mainly based on the 3 equation model is which is also known as New Keynesian model it includes :

1. IS curve (equilibrium in goods market)
2. Philiips Curve (unemployement inflation relationship)
3. MR Curve (how the central bank responds to shocks i.e. interest rate based monetary policy rule)

The IS diagram is placed vertically above the Phillips curve diagram, with the monetary rule shown in the latter along with the Phillips curves. The 3 equations are

• IS equation: y1 = A − ar0  

where, y = real income ; A = autonomus expenditure ; r = real interest rate

• Phillips curve: π1 = π0 + α (y1 − ye)

where, π = rate of inflation ; ye = equilibrium output

• The central bank’s Monetary Rule

Equilibrium output is the level of output associated with constant inflation. In a world of imperfect competition it reflects the mark-up and structural features of the labour market and welfare state.