Comment of the Day: Robert Waldmann: "I bore myself. However, I have two objections to 'It was Karl Smith who pointed out to me that in the guts of even the IS-LM model...

...fiscal policy expands I+G by reducing the perceived average riskiness of and thus getting households to hold more. '

  1. typo alert I think that 'of and' should be 'of debt and'
  2. in the guts of the IS-LM model fiscal policy is not one dimensional. One type of fiscal policy analysed with the IS-LM model is a balanced budget increase in G and T. I do not think that this expands I+G by affecting the perceived average riskinyess of anything.

I really do bore myself. I think I have been typing comments along the lines of 'what about a balanced budget increase in G ? According to your argument that should have zero effect on aggregate demand. Do you really believe this ?' for 5 years now.

If I recall correctly, from time to time, you have replied to these comments and agreed that this is another issue which is relevant to both reality and the IS-LM model. But then I find another post in which fiscal policy is defined as deliberately increased deficits. The post have included the phrase 'the solution' which asserts that a balanced budget increase in G and T would not work.

I am by now deeply deeply bored by this comment. But I am also deeply puzzled by your use of the phrase 'fiscal policy' and the acronyme 'IS-LM'. I have a guess about what is going on. Even in a discussion of economics and an economic model, you internalize the political constraint. You noticed that in 2009 it was impossible to get spending increases without tax cuts. You know that significant tax increases are almost completely politically impossible. So you banish all thought of a conceivable but not politically possible balanced budget increase in G from your mind. I think, it is necessary to consider politically impossible hypotheticals to disect the IS-LM model and find what is in its guts.