Consumption Function and Keynesian Cross under Dynamic Optimization

Abstract

Keynesian cross analysis has been criticized because it utilizes the ad-hoc consumption function. By introducing insatiable money preference into a macroeconomic model with dynamic optimization, Murota and Ono (2015) obtain a new consumption function with similar mathematical properties to the conventional ones and present a new Keynesian cross analysis. We extend it to a model that consistently treats a closed and a small open economy. While the conventional Keynesian cross analysis and the Mundell-Fleming model give different policy implications, our model gives consistent ones in the two cases. Government purchases increase aggregate demand while monetary policies do not.