Why IS-LM still isn’t good enough (wonkish)

30 October, 2012 at 16:01 | Posted in Economics | Comments Off on Why IS-LM still isn’t good enough (wonkish)

Matias Vernengo has a piece today on Naked Keynesianism giving us yet another clue to why IS-LM – and its different hybrids – still isn’t up to the task of helping students to grasp the essentials of modern monetary economies:

Wendy Carlin and David Soskice have an interesting post at Voxeu.org on “How should macroeconomics be taught to undergraduates in the post-crisis era.” They explicitly follow … a New Keynesian framework. Which is an ISMP model with price rigidities …

In their view, the monetary authority can move the economy to the equilibrium rate, but the equilibrium rate is not controlled by the authorities. I would suggest that the central bank actually has control of the key variable, which is not natural at all, and as Keynes suggested is conventional, the normal rate of interest. And that could be set at a level which will not lead to full employment, particularly for distributive reasons. In my view the essential feature of a more relevant macro model would be the elimination of the natural rate, the idea that the system has a tendency to bounce back to the trend …

And by the way, the model says nothing about how income distribution affects spending.Yet, the main reason behind the crisis has been the fact that workers had to get indebted, since income has stagnated. So income distribution has to be brought back to macroeconomics. Not enough Kalecki, with their New (but still neoclassical) version of Keynesianism, that is the problem with Carlin and Soskice.

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