Krugman doesn’t understand IS-LM (Part 4)
But first, a word about my Kickstarter campaign to raise funds to develop Minsky, a tool for designing strictly monetary macroeconomic models:
There are only 58 hours left to help Kickstart Minsky! We've raised $65,000 now, which puts us within striking distance of our first stretch goals:
About 1400 hours of total programming time will enable Russell to complete the “Mun” release, which will focus on improving the graphics and presentation aspects of the program.
Nathan will also be able to develop a version of Minsky for iPad and Android Tablets.
I'm also not about to give up hope that we might make the second stretch goal:
With twice as much as the original INET Grant, we should be able to complete stage 2 of Minsky—the “Quesnay” release named in honor of the person I regard as the world’s first dynamic economist, Francois Quesnay—in which the platform could support the construction of multi-bank model of the financial sector, and a multi-commodity model of production.
Krugman doesn't understand IS-LM (Part 4)
So where is the economy, in terms of the IS-LM diagram? It isn’t, as soon as you acknowledge that the economy is in disequilibrium, the IS-LM model can’t be used to represent it.
Some neoclassical economists think you can make IS-LM into a dynamic model by drawing phase diagrams onto an IS-LM backdrop, showing how the model will move when you start from a disequilibrium position. But that doesn’t work either, and again this is because the model is fundamentally a Walrasian one – not a Keynesian one.
Have you ever wondered how a purportedly macroeconomic tool like IS-LM can omit the labour market? It does so because John Hicks used Walras’ Law to ignore it: using the logic that if the goods (IS) and money (LM) markets were both in equilibrium, any third market must also be. But this depends crucially on equilibrium: in equilibrium, using Walras’ logic, as Hicks did to conceive of IS-LM in the first place, you can omit a third crucial market from a general model because it will be determined by what happens in the other two: