# The new Keynesian IS curve: What determines output?

The New Keynesian IS curve can be described by the following (log-linearisation around the steady-state):$$y_t=E_t(y_{t+1})- \frac{1}{\theta}(i_t - E_t\pi_{t+1}-\rho)$$ where $$\displaystyle\frac{1}{\theta}$$ is the intertemporal elasticity of substitution in consumption, $$\rho$$ the discount rate, and the remaining terms have their usual interpretation.

In the book Dynamic Macroeconomics, by Alogoskoufis, in chapter 16 (page 461), the author states:

Recall that this is nothing more than the Euler equation for consumption, supplemented by the assumption that all output is consumed, and the same relation was derived in the new classical model [it's eq. 14.10] of chapter14. However, in contrast to the new classical model, where output is determined by aggregate supply, in this model, because of staggered pricing, output is determined by aggregate demand. Thus, it is the IS curve that drives output ﬂuctuations.

I do not understand in what way is the output being determined by aggregate supply in the free price setting, nor by the aggregate demand in the sticky prices one.

• Thanks, for your answer. I think I understand what you're saying and it makes sense... However, it seems to me that I can only conclude the way you have after completely defining the model, and solving it for $y_t$. From the equations the author had shown so far, this could not be deduced, I think. Or am I wrong? – An old man in the sea. Jan 3 at 20:59
• Yes, the author does show how to reach that version of the IS. I think I expressed myself in a wrong way. What I meant was, in which equation do you see that $y_t = \text{aggregate demand}$? – An old man in the sea. Jan 3 at 21:26