If the Fed doubled the money supply would you suddenly change your preferences and want to hold twice as much cash in your wallet?
To which I retort: if you suddenly found yourself with twice as much cash in your wallet, would you double your spending?
When the Fed lends money to banks in the repo market, by purchasing Treasury securities that the bank agrees to repurchase a week or so later, it causes ripples in the financial system. Various institutions adjust their portfolios in response. My view is that these ripples are quite small in the grand scheme of things. Long-term credit markets (where mortgage rates are determined) may ignore the ripples. Markets for risky corporate debt may ignore the ripples.
Think of there being many, many money supplies: M0, M1, M2, M3, ... The Fed causes some ripples in M0 and M1, but to affect the economy it needs to affect M75 or somesuch. And the ripples die out by the time we get there.
Yes, I am an outlier in this belief. Krugman only argues that we are in a liquidity trap when interest rates are near zero. I think that we are in a liquidity trap any time we do not have inflation approaching double digits.
Bryan says that he thinks of the LM curve as vertical. I guess think of it as horizontal, because I think that money demand is very loosey-goosey. Sometimes you wiggle M0 and you get a response in M4. At other times, you only see a response in M3. It depends on what the institutional habits are at the time. But if you need to get a response from M75, then good luck.
I really don't like to talk about LM curves and IS curves, though. I don't like to use "secret code" that some readers are not familiar with. Moreover, I think IS-LM confuses even those of us who know what the terms mean.
The most important thing going on in financial markets right now is de-leveraging, which means that everybody wants to sell risky assets and buy U.S. Treasuries. Where do you stick that in the IS-LM framework? Treat it as an increase in liquidity preference and shift the LM curve? Treat it as a drop in animal spirits and shift the IS curve?
It's hard enough to figure out what is going on. Trying to translate what is going on into IS-LM jargon just makes it harder, at least for me.