IS/LM model
The IS/LM model was used from 1936 onwards to summarize
Keynesian macroeconomics. It can be presented as a graph
of two intersecting lines in the first quadrant.
The abscissa represents national income[?] and is labelled
Y. The ordinate represents the interest rate, r. The
IS schedule is drawn as an downward-sloping curve. The
LM schedule is a upward-sloping curve. The point
where these schedules intersect represents a short-run
equilibrium[?] in the real and monetary sectors.
The IS schedule is a locus of points[?] of equilibrium
in the "real" economy. Given expectations about returns
on investment, every level of income and interest
rates will generate a certain level of investment.
Income is at the equilibrium level for a given
interest rates when the savings consumers choose to make
out of that income equals investment. A higher level
of income is needed to generate a higher level of
savings at a given interest rate. This helps
generate the downward slope of the IS schedule.
The Keynesian hypothesis is that deficit spending[?] is
like a lower savings rate. An increased deficit by
the national government shifts the IS curve to the
right.
LM summarizes monetary equilibrium.
LM curve drawn for given money supply
The IS/LM model was born at the Econometric Conference
held in Oxford during September, 1936. Roy Harrod[?],
John R. Hicks, and James Meade[?] all presented papers
describing mathematical models attempting to
summarize John Maynard Keynes' General Theory
of Employment, Interest, and Money. Hicks,
who had seen a draft of Harrod's paper, invented
the IS/LM model. He later presented it in
"Mr. Keynes and the Classics: A Suggested
Reinterpretation" (Econometrica, April 1937).
Extension to labor market. Don Patinkin[?], Franco Modigliani insist requires sticky or rigid
prices or money wages.
Keynesian vs Monetarism - relative slopes
Hicks later agreed missed important points in Keynes.
Presents real and monetary sectors as separate, Keynes
attempted to transcend this.
Equilibrium model, ignores uncertainty.
Shift in IS or LM curve will cause change in expectations.
Other curve will shift.
Keynes post-GT finance affect will cause interaction
between curves.
What about threat of bankruptcy when wages and prices
fall?