Deconstructing the Macroeconomics' IS-LM Model: Its Assumptions and Simplifications

Abstract

The IS-LM model emerges from the academic impact of Keynes’ General Theory of Employment, Interest and Money (GT). It was developed afterwards, in the late 1930s, starting to be called the Hicks-Hansen model; though other academics such as Harrod and Mead contributed to it. In this regard, the model consisted of a way of mathematising the core of Keynes’ GT (though Keynes did not recognise it as such); it was fully developed and consolidated as the academic new paradigm across the 1950s and 1960s. However, it was not (and is not) properly considered as a formalisation of the GT but as an independent development inspired by it. A compromise distinction in this regard has become generally accepted: the label ‘economics of Keynes’ for referring to his GT and derived developments, and ‘Keynesian economics’ for the IS-LM construct and its derivatives .
With its double equilibrium (Investment=Savings; Money Supply=Demand for Liquidity), the model sort of plays in standard Macroeconomics a parallel role to that of the ‘General-Equilibrium-of-competitive-markets’ in Economics/Microeconomics. This IS-LM model remains either as fundamental or is simply present in most popular mainstream macroeconomic manuals, as well as those of economic policy ‒especially monetary policy‒ texts.

Keywords: Explanatory Models in Economics, Post-Keynesian Economics, IS-LM model, Macroeconomics Teaching

JEL Classification: B22, E12, E20, E40