Keynesian Macroeconomics without the LM Curve

T he IS-LM model has been a central tool of macroeconomic teaching and practice for over half a century. Legions of earlier writers have offered criticisms of the model that have become familiar with the passage of time: the model lacks microeconomic foundations, assumes price stickiness, has no role for expectations, and simplifies the economy’s complexities to a handful of crude aggregate relationships. But countless teachers, students, and policymakers have found the model to be a powerful framework for understanding macroeconomic fluctuations. Recent developments have created new difficulties for the IS-LM model. Although the new difficulties are less profound than the traditional ones, they are more likely to be fatal. Like all models, the IS-LM model is not universal. Its assumptions and simplifications make it better suited to analyzing some issues than others, and to describing some economic environments than others. But neither the issues nor the environment of macroeconomic fluctuations are fixed. In terms of issues, one major change is that the debates between Keynesians and monetarists about the relative effectiveness of monetary and fiscal policy that were central to macroeconomics in the 1960s and 1970s now play only a modest role in the analysis of short-run fluctuations. In terms of the environment, one important change is that most central banks, including the U.S. Federal Reserve, now pay little attention to monetary aggregates in conducting policy. But the IS-LM model is particularly well-suited to presenting the debates between Keynesians and monetarists, and one of its basic assumptions is that the central bank targets the money supply. In short, recent developments work to the disadvantage of IS-LM. This observation suggests that it is time to revisit the question of whether IS-LM is the best