The Workhorse of Keynesian MacroeconomicsBy
1937 Sir John Hicks, a British economist, introduces the IS-LM model, the workhorse of macroeconomics.
IS-LM (investment-savings, liquidity-money) is an explanation of the Keynesian view of how an economy works. The economy is in equilibrium at the intersection of the IS line and the LM line. At that level of interest rates and gross domestic product, the supply and demand for savings (IS) is in balance, and so is the supply and demand for money (LM). If there’s pessimism about growth, the IS line shifts to the left and the equilibrium interest rate falls. But if the IS line shifts too far left, even a zero-interest rate isn’t low enough to stimulate economic growth. That’s a “liquidity trap.” At that point, conventional monetary policy is, in a classic description, as useless as attaching a string to an anvil and pushing on the string.