Tuesday, February 10, 2015

Matias Vernengo — Teaching macroeconomics: the resilience of the ISLM model

The interesting thing is that, although the ISLM is less used in theory, in particular because the multiplier story at the core of the IS has been substituted by a Ramsey intertemporal maximization story and the LM has been substituted by a Wicksellian interest rate rule, it is still the workhorse of macroeconomic teaching, and likely of simple policy thinking. In many ways the ISLM remains a much better basis for thinking about the economy than modern New Keynesian DSGE models (if nothing else because of the multiplier).
But is it still ISLM?

I don't have an issue with using gadgets to teach Econ 101 as long as they are presented as such. As far as using gadgets for policymaking, hmmm (thinks monetarism with a small m).

Naked Keynesianism
Teaching macroeconomics: the resilience of the ISLM model
Matias Vernengo | Associate Professor of Economics, Bucknell University

1 comment:

circuit said...

Yes, it's still an ISLM. James Meade long ago criticized the model because it assumes the central bank sets the money supply rather than the rate of interest. This is a minor point. The LM or the MP curve slopes the same way and has minimal impact on its relevance for analysis, the core of which is that one curve represents fiscal policy (IS) and the other represents monetary policy (LM or MP).

Matias's students are lucky, and will will find their classes on ISLM useful if they one day work for a central bank. For instance, the Fed and the Bank of Canada both use a model that relies on a sort of IS curve (combined with a MP-type of reaction function).