IS/LM

...sounds to me like it should be part of a tobacco pitch, but apparently not.

Some of you may recall that I'm something of a student of the Austro-Bahamian school of economics, as exemplified by the writings of its foremost exponent. Of course his works are occasionally a bit cryptic, even Derridesque, perhaps.

Anyway, he recently trashed the famous IS/LM model, which made me think that if it's that bad, I really ought to at least try to understand it.

It seems that the model is actually two curves, often drawn as straight lines, in a space that represents interest rates (vertical axis) and gross domestic product (horizontal axis), as above. Now if you suspect that econo-space might have more dimensions than two, just consider it a two-slice of that hyperspace. The two curves represent hypothetical equilibria, with the participants being S, the propensity to save; I, the demand for investment; L, the so-called liquidity preference; and M, the money supply.

The working assumption is that propensity to save depends on the interest rate, and that the demand for investment depends on the interest in an inverse way. The market, in theory, should adjust interest rates until the supply of savings matches the demand for investment. Next we assume that the GDP depends on the interest rate, so that lower (real) interest rates increase GDP. Consequently, the IS curve is expected to slope downward and to the right.

The second curve is based on another posited equilibrium, that between liquidity preference (preferring to keep your cash in checking, or under the bed, instead of in bonds) on the one hand, and the supply of money that the Fed (or whomever puts in the system). Liquidity preference should decrease with increasing interest rates and interest rates should decrease with increasing money supply. Since GDP is expected to increase with increasing money supply, this curve is usually expected to slope upward to the right.

The intersection of these two curves, the first in what might be called in "real" space, and the second in"monetary" space, supposedly represents a grand equilibrium.

Problems and defects of IS/LM are discussed in A-B above, and in the Wikipedia article, both linked above. The meaning, use and applicability of the model to present circumstances is discussed rather nicely by Krugman.

Corrections to my interpretation welcomed.

Comments

Post a Comment

Popular posts from this blog

Anti-Libertarian: re-post

The most pointed critique of social security and liberalism in general is the libertarian critique. The problem with libertarians, for a liberal, is that we have too much in common. We both believe in individual rights, tolerance of individual differences, and dislike government prescription of religion. The basic difference, it seems to me, is the different answers we give to Cain's (with thanks to the Captain - my original version had the corpse asking the question!) famous question: "Am I my brother's keeper?" That's not really my basic bitch against the libertarians though. My real complaint is the same as my complaint against most religion - its premise is a fraud. For those who can't stand to wait for the punchline, I believe that trying to implement libertarian principles leads to tyranny or social disintegration. Demonstrating that takes some historical (and pre-historical) context. For all but the last 15,000 or so of the 100,000 years the human spec
Read more

Uneasy Lies The Head

Uneasy lies the head that wears a crown ........... Shakespeare Henry IV, Part II. So it is with us and our slightly distant primate cousins , so it seems. A 9-year study of wild baboons in Kenya by Princeton University and the Institute of Primate Research may turn conventional assumptions of alphas males upside down. The study found that alpha males have high testosterone levels, which allows them to dominate other baboons, get access to more food, and attract better mates. This is expected. Surprisingly, though, the alpha males also have high levels of stress hormone glucocorticoid, which scientists measured from their feces samples. In fact, the stress of alpha baboons was on par with low-ranking baboons. The convention wisdom is that access to food and females provides life security and thus less stress for dominant males. Conversely, weak males who are constantly threatened by starvation and physical violence from stronger males are thought to be more stressed. The st
Read more

We Call it Soccer

The US played its best, and maybe only good game of World Cup, but lost thanks to brilliant goalkeeping by the Swedish keeper and the bizarre method soccer uses to settle ties when three US stars could not put the ball on frame from the 12 yard spot.  At the end it came down to a blocked shot that spun in by maybe a couple of centimeters. Well, that's football - too much like life.   Which brings me to a modest proposal.  Replace the thirty minute overtimes with as many 7-player 15 minute periods as needed to settle it.  Scoring should be much easier with fewer players.
Read more