Arnold Kling  

The IS-LM Model Attacked and Defended

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Tyler Cowen writes,


Every time you write down an IS-LM model you should hear a clock start ticking in your head. The longer the clock ticks, you more you need to worry about this problem because the more that a) the price level may change, or b) expectations about future price level changes will start to matter.

In defense of the IS-LM model, Arlo would like to make the following points.

1. The IS-LM model is a pedagogical device for teaching elementary/intermediate macro. It presents the Keynesian (or Hicksian) view of the joint determination of interest rates and output in a clear way.

2. Assume that the price level is fixed and the term premium is constant, if that will make you feel better.

3. Tyler's point three is about facets of monetary theory that are problematic for reasons have nothing to do with IS-LM.

4. Assume that expectations are fixed, if that will make you feel better.

5. Try explaining Keynes' arguments for why monetary policy is ineffective. Your IS-LM pedagogue will be showing the interest inelasticity of investment as a vertical IS curve and the liquidity trap as a horizontal LM curve at the vertical axis. What have you got?


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COMMENTS (5 to date)
Becon writes:

2. Assume that the price level is fixed and the term premium is constant, if that will make you feel better.

I don't like to assume untrue things to make me feel better. (Fans of Jesus would disagree.)

Tracy W writes:

My problem with the IS-LM model is that it was presented to me, at uni, with no supporting evidence that the economy actually operated like that.
Put me right off macro.

Nick Rowe writes:

Yep. Another way of saying what you are saying: the biggest problem with ISLM is that university chalkboards only have 2 dimensions. Add a third dimension, and put P on the axis. Add a fourth and put expected inflation on the axis. Add a fifth and put the yield spread on the axis. Add a sixth and put time on the axis, and tie all the other axes together.

Norman writes:

Becon,

So I assume you don't use supply/demand analysis, either? After all, income levels and the prices of related goods and factors aren't truly constant, either.

AJ writes:

Yea, let's pretend we have an entire economy with markets where the prices do not change or adjust to individual market factors.

Macroeconomics is so moronic -- There is no economics in Macroeconomics.

Unfortunately, I was in the middle of my Ph.D. program at M.I.T. economics when I figured that out.

Macroeconomics and ISLM is the ultimate emperor with no clothes.

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