On J. M. Keynes's Initial IS-LM Approach in 1933 and 1934: Its Connection to Liquidity Preference, the Weight of Evidence, the A Treatise on Probability, and Keynes's Aggregate Supply Curve from Chapter 20 of the General Theory
24 Pages Posted: 10 Jan 2017
Date Written: January 6, 2017
J M Keynes had worked out his own version of IS-LM based on his weight of the evidence analysis from the A Treatise on Probability, 1921, in 1933 and 1934 before publishing the General Theory in February, 1936. However, he decided not to use it because it had no microeconomic foundations and did not incorporate explicit price and profit expectations in the model for both the LM and IS curves. Instead, Keynes, in chapter 20 of the General Theory, constructed the mathematical model of his Theory of Effective Demand that was introduced in chapter 3 of the General Theory. Keynes’s major result was his development of his Aggregate Supply Curve, which is a locus of the set of all expected D=Z intersections. Each point on this locus satisfied the necessary and sufficient first and second order conditions for being an expected profit maximum. Thus, the aggregate supply curve is the set of all possible, multiple equilibria in an economy that are optimal. Only one of the possible equilibria will be a full employment equilibrium. All of the remaining equilibria will be under employment or unemployment equilibria. Indirectly, Hicks, Hansen, Harrod and Meade presented various versions that were partly consistent with Keynes’s mathematical model from chapters 20 and 21 in 1937. Only one came close-James Meade.
It is not possible to fully understand Keynes’s own, original version of the IS-LM curves unless a reader can follow the explicit links made by Keynes in the General Theory to Keynes’s analysis of the weight of the argument (evidence) in the A Treatise on Probability. Keynes’s analysis of Liquidity Preference, based on Keynes’s explicit definition of uncertainty as being an inverse function of weight alone on p. 148 of the General Theory, was tied by Keynes to Liquidity preference as behavior toward uncertainty.
No economist, especially of the Post Keynesian or Institutionalist type, accepted Keynes’s very clear cut definition that Uncertainty is an inverse function of weight alone.
Therefore, this failure to comprehend the concept of weight by economists explains why no economist was able to realize that Keynes was the creator of his own, original version of the IS-LM model.
All economists, who use the IS-LM model, are thus Keynesians of one degree or another. Of course, many economists have their own version of the IS-LM model and are not able to see the direct connection between the weight of evidence and Liquidity Preference because they do not understand Keynes’s logical theory of Probability.
Keywords: IS, LM, vertical LM, horizontal LM, Aggregate Supply Curve, weight of the evidence, liquidity preference
JEL Classification: B10, B12, B14, B20, B22
Suggested Citation: Suggested Citation