IS–LM model
John Hicks stood before the Econometric Society in Oxford during September 1936 to present a new mathematical framework. He had just invented what would become known as the IS-LM model, though he originally called it the LL curve instead of LM. Roy Harrod and James Meade also presented papers at that same conference attempting to summarize John Maynard Keynes' General Theory of Employment, Interest, and Money. Hicks used his draft paper from Harrod as inspiration to create this two-dimensional diagram showing how interest rates relate to output. The intersection of these curves illustrated a general equilibrium where both goods markets and money markets reached balance simultaneously. This moment marked the birth of a tool that would dominate macroeconomic analysis for decades.
Alvin Hansen extended John Hicks original contribution throughout the 1930s and early 1940s into a full mathematical representation of Keynesian theory. Between the 1940s and mid-1970s their combined work became the leading framework for macroeconomic analysis. The model showed how lower interest rates encouraged higher investment and spending which raised real GDP through a multiplier effect. Every level of the real interest rate generated a certain level of investment and spending along the downward-sloping IS curve. The upward-sloping LM curve represented combinations of interest rates and income levels where money demand equaled money supply. Central banks determined money supply as perfectly inelastic with respect to nominal interest rates during this period.
Central banks generally changed strategies towards targeting inflation rather than money growth starting from the early 1990s. David Romer published suggestions in 2000 replacing the traditional positively sloped LM curve with a horizontal MP curve standing for monetary policy. John B. Taylor independently made similar recommendations in that same year after central banks started paying little attention to money supply when deciding on policy. Olivier Blanchard updated his widely-used intermediate-level textbook Macroeconomics in its 7th edition released in 2017 to reflect these changes. Modern versions now show the central bank determining the policy interest rate as an exogenous variable directly instead of influencing it indirectly via controlling money supply.
The original model assumed fixed price levels so it could not analyze inflation which became problematic with rising inflation levels in the late 1960s and 1970s. Economists integrated aggregate supply into larger frameworks like the AD-AS model to explain rises in the price level. Daron Acemoglu, David Laibson, and John A. List named their corresponding model combining IS-LM with changing price levels as an IS-LM-FE model in their 2018 textbook Macroeconomics. Many modern textbooks replaced the traditional AD-AS diagram with variations using output and inflation variables derived from Phillips curve relationships between inflation and unemployment gaps. This formulation allows analysis of both short-run and medium-run economic conditions while accounting for flexible price levels.
Today the IS-LM model is largely absent from macroeconomic research but remains a backbone conceptual introductory tool in many undergraduate textbooks. It serves as a pedagogical device showing how demand shocks affect output when prices are sticky or fixed. Advanced economic courses generally accept the model as imperfect and skip its use in favor of more complex dynamic models. Students learn that government deficit spending shifts the IS curve rightward raising equilibrium interest rates and national income. The framework helps illustrate debates about whether fiscal or monetary policy was most effective to stabilize economies during the 1960s and 1970s before these issues faded from focus.
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Common questions
When did John Hicks present the IS-LM model to the Econometric Society?
John Hicks presented the new mathematical framework at the Econometric Society in Oxford during September 1936. He originally called it the LL curve instead of LM before the name changed.
What do the downward-sloping IS curve and upward-sloping LM curve represent in the original model?
The downward-sloping IS curve shows how every level of real interest rate generates a certain level of investment and spending. The upward-sloping LM curve represents combinations of interest rates and income levels where money demand equals money supply.
Why did economists replace the traditional positively sloped LM curve with a horizontal MP curve starting in 2000?
David Romer published suggestions in 2000 replacing the traditional positively sloped LM curve with a horizontal MP curve because central banks started paying little attention to money supply when deciding on policy. Central banks generally changed strategies towards targeting inflation rather than money growth starting from the early 1990s.
How does the IS-LM-FE model differ from the original IS-LM model regarding price levels?
Daron Acemoglu, David Laibson, and John A. List named their corresponding model combining IS-LM with changing price levels as an IS-LM-FE model in their 2018 textbook Macroeconomics. The original model assumed fixed price levels so it could not analyze inflation which became problematic with rising inflation levels in the late 1960s and 1970s.
What is the current status of the IS-LM model in modern macroeconomic research and textbooks?
Today the IS-LM model is largely absent from macroeconomic research but remains a backbone conceptual introductory tool in many undergraduate textbooks. Advanced economic courses generally accept the model as imperfect and skip its use in favor of more complex dynamic models.
All sources
20 references cited across the entry
- 1journalA Simplified Model of Mr. Keynes' SystemJ. E. Meade — 1937
- 2journalMr. Keynes and the 'Classics': A Suggested InterpretationJ. R. Hicks — 1937
- 3bookA Guide to KeynesA. H. Hansen — McGraw Hill — 1953
- 4bookAn Eponymous Dictionary of Economics: A Guide to Laws and Theorems Named after EconomistsSamuel Bentolila — Edward Elgar — 2005
- 5journalKeynesian Macroeconomics without the LM CurveDavid Romer — 1 May 2000
- 6bookMacroeconomicsOlivier Blanchard — Pearson — 2021
- 7journalTeaching Modern Macroeconomics at the Principles LevelJohn B. Taylor — May 2000
- 8bookAdvanced macroeconomicsDavid Romer — McGraw-Hill — 2019
- 9bookIntroducing advanced macroeconomics: growth and business cyclesPeter Birch Sørensen et al. — Oxford University Press — 2022
- 10journalThe Strange Persistence of the IS-LM ModelDavid Colander — 2004
- 11webThe Macroeconomist as Scientist and EngineerN. Gregory Mankiw — May 2006
- 12bookMacroeconomicsRobert J. Gordon — Pearson Addison Wesley — 2009
- 13webWhat do we teach in Macroeconomics? Evidence of a Theoretical DivideFrançois Courtoy et al. — UCLouvain
- 14journalTeaching post-intermediate macroeconomics with a dynamic 3-equation modelLeila E. Davis et al. — 2 October 2022
- 15journalWhat Should be Taught in Intermediate Macroeconomics?Pedro de Araujo et al. — January 2013
- 16journalIntermediate Macroeconomics without the IS-LM ModelAkila Weerapana — 2003
- 17bookMacroeconomicsDaron Acemoglu — Pearson — 2018
- 18bookMacroeconomicsNicholas Gregory Mankiw — Worth Publishers, Macmillan Learning — 2022
- 19newsReinventing IS-LM: The IS-LM-NAC model and how to use itRoger E. A. Farmer — 2016-09-02
- 20journalAnimal spirits in a monetary modelRoger E. A. Farmer et al. — 2019