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Monday, February 14, 2011

Ashamed to admit it, but...

Today I went through a properly rigorous mathematical treatment of the basic IS-LM model for the first time.  Alpha Chiang gives an excellent treatment of the IS-LM framework in his Fundamental Methods of Mathematical Economics.

I am embarrassed to say that this is my first time going through IS-LM!  I assume that this would be something that a second (or maybe even first) year undergraduate would have encountered.  I am only slightly absolved because I never studied undergraduate economics.  It was covered, very briefly, in my MSc at the University of Edinburgh.  However it wasn't stressed as being useful, and we weren't examined on it.

Having spent my entire day going through increasingly sophisticated versions of IS-LM, I feel pretty good.  I feel like I learned quite a bit about how the macroeconomy works.  I pose to my readers the following question: Why is it that some economists believe that IS-LM has been discredited?

I take as given that the economists in question are extremely intelligent and have thought deeply about the issues there must be some other reason.  I was actually surprised that a Google search for: IS-LM "discredited" turned up (for the most part) fairly positive articles.  If anyone has what they think is a convincing refutation of the IS-LM framework I would appreciate it if you send a pointer in my direction!

I will be teaching a very basic (and non-mathematical) version of the model in first year macroeconomics in a few weeks...

Update: Sean passed Tyler Cowen's critique of IS-LM to me via email.  My quick take on Tyler's critiques: points 1 and 4 are well taken.  Point 2 (and to a lesser extent point 5) would seem to implicitly assume that investment decisions are made solely on the basis of real and not nominal variables.


  1. I summarized three objections to the IS/LM model about two years ago.

  2. Robert,

    Thanks for the pointer. I like the IS/LM model. I feel like it gives a very rough but reasonably accurate first approximation of the relationships between major macro-economic aggregates. As I mentioned in the post, I am going to be teaching a version of the IS/LM model to first year undergraduates, so I want to make sure I have a solid understanding of the model's strong and weak points.

    Any particular alternative that you would suggest that would be teachable to first-year undergraduates?

    (Big fan of your blog by the way...I am particularly fond of your posts on the problems with General Equilibrium theory).

  3. Robert/David,

    I don't follow the first of your objections - the LM curve shows a continuum of equilibria where the stock of money remains constant and velocity of circulation increases with income. I think the conceptual problem is that the flow implied by the LM curve is roughly circular whilst the flow implied by the IS curve is roughly directed (ie from production to consumption), and that the measuring the former is reliant on having measured the latter (it's difficult to imagine an ex ante velocity of money!)

    I couldn't agree more with your second and third objections though.