IS-LM
Scott Sumner writes:
The Money Illusion:More Reverse Causation: I have to confess that I don’t understand the IS-LM model very well, as I never us it in teaching...
Hmmm... My first reaction is "what's to understand?" If you use the quantity theory of money--well, that is the LM curve. Even if you deny that money demand is interest elastic, well, that is still the LM curve--it is merely a vertical LM curve. If you use the real flow-of-funds balance through financial markets or the income-expenditure framework with exports and investment depending on the real interest rate--well, that's the IS curve. You then have to stitch them together, which requires a model of (a) expected inflation, (b) term premia, (c) default premia, (d) information premia, and (e) risk premia. But I have not yet seen a theory of nominal spending or real output determination that does not have an IS-LM representation...
