Tuesday, October 4, 2011

Brad DeLong Explains IS-LM

No much commentary on this one, just a good read for anyone interested in the subject (excerpt):

The Tribal Dislike of John Hicks and IS-LM: History of Economic Thought Edition

When you do economics and apply it to the real world, you start with the simplest possible model. Does that help you understand enough of the real world to satisfy you? If not, you complicate it by adding the most important thing that you had left out. Does that help you understand enough of the real world to satisfy you? If so, you use that model--and then when you want to go further you complicate it in its turn.

But at each stage in the process, you absorb the valid insights from your current model before you go on to complicate things further.

If you’re not familiar with the subject, or didn’t take macroeconomics at university, then the IS-LM model is Sir John Hicks attempt at explaining Keynes. Unfortunately, the underlying basis that he used for constructing the model was partially faulty (Keynes rejected the notion of a unique equilibrium), and Hick’s in fact repudiated IS-LM later in his career. By then it was too late, as a full generation of American economists had taken it up and hijacked the intellectual leadership of Keynesian economics, even if what they actually practiced was actually a bastardised amalgam of Keynes and neo-classical thought, commonly called the neo-classical synthesis.

Nevertheless, as DeLong points out, it doesn’t invalidate the potential usefulness of the model to examine policy issues, as long as it isn’t that badly wrong.

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