IS-LM is bad economics no matter what Krugman says

20 mars, 2013 kl. 14:26 | Publicerat i Economics | 13 kommentarer

Paul Krugman has a post up on his blog once again defending ”the whole enterprise of Keynes/Hicks macroeconomic theory” and especially his own somewhat idiosyncratic version of IS-LM.

The main problem is simpliciter that there is no such thing as a Keynes-Hicks macroeconomic theory!

So, let us get some things straight.

There is nothing in the post-General Theory writings of Keynes that suggests him considering Hicks’s IS-LM anywhere near a faithful rendering of his thought. In Keynes’s canonical statement of the essence of his theory in the 1937 QJE-article there is nothing to even suggest that Keynes would have thought the existence of a Keynes-Hicks-IS-LM-theory anything but pure nonsense. So of course there can’t be any ”vindication for the whole enterprise of Keynes/Hicks macroeconomic theory” – simply because ”Keynes/Hicks” never existed.

And it gets even worse!

John Hicks, the man who invented IS-LM in his 1937 Econometrica review of Keynes’ General TheoryMr. Keynes and the ‘Classics’. A Suggested Interpretation – returned to it in an article in 1980 – IS-LM: an explanation – in Journal of Post Keynesian Economics. Self-critically he wrote:

I accordingly conclude that the only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better – is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous, but because I want to ask him to try to assure himself that the divergences between reality and the theoretical model, which he is using to explain it, are no more than divergences which he is entitled to overlook. I am quite prepared to believe that there are cases where he is entitled to overlook them. But the issue is one which needs to be faced in each case.

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect. For one cannot prescribe policy without considering at least the possibility that policy may be changed. There can be no change of policy if everything is to go on as expected-if the economy is to remain in what (however approximately) may be regarded as its existing equilibrium. It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

I have paid no attention, in this article, to another weakness of IS-LM analysis, of which I am fully aware; for it is a weakness which it shares with General Theory itself. It is well known that in later developments of Keynesian theory, the long-term rate of interest (which does figure, excessively, in Keynes’ own presentation and is presumably represented by the r of the diagram) has been taken down a peg from the position it appeared to occupy in Keynes. We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

The editor of JPKE, Paul Davidson, gives the background to Hicks’s article:

I originally published an article about Keynes’s finance motive — which in 1937 Keynes added to his other liquidity preference motives (transactions, precautionary, speculative motives) , I showed that adding this finance motive required that Hicks’s IS curve and LM curves to be interdependent — and thus when the IS curve shifted so would the LM curve.
Hicks and I then discussed this when we met several times.
When I first started to think about the ergodic vs. nonergodic dischotomy, I sent to Hicks some preliminary drafts of articles I would be writing about nonergodic processes. Then John and I met several times to discuss this matter further and I finally convinced him to write the article — which I published in the Journal of Post Keynesian Economics– in which he renounces the IS-LM apparatus. Hicks then wrote me a letter in which he thought the word nonergodic was wonderful and said he wanted to lable his approach to macroeconomics as nonergodic!

So – back in 1937 John Hicks said that he was building a model of John Maynard Keynes’ General Theory. In 1980 he openly admits he wasn’t.

What Hicks acknowledges in 1980 is basically that his original review totally ignored the very core of Keynes’ theory – uncertainty. In doing this he actually turned the train of macroeconomics on the wrong tracks for decades. It’s about time that neoclassical economists – as Krugman, Mankiw, or what have you – set the record straight and stop promoting something that the creator himself admits was a total failure. Why not study the real thing itself – General Theory – in full and without looking the other way when it comes to non-ergodicity and uncertainty?

Paul Krugman persists in talking about a Keynes-Hicks-IS-LM-model that really never existed. It’s deeply disappointing. You would expect more from a Nobel prize winner.

13 kommentarer

  1. The theory is not real economics so

  2. Intressant om Hicks!

    Samtidigt är ju världen full av tviverlaktiga namn som förknippar personer med teorier eller åsikter som de inte skulle stått för om de levt och kunnat förklara sig. Det viktigaste när det gäller IS-LM-modellen är ju om den kan säga något relevant om världen eller inte, och våra tankar om det bör ju inte styras i särskilt hög grad av vad Keynes eller Hicks skulle ansett.

    För att bedöma modellers relevans har vi ju som i annan vetenskap att försöka så klokt som möjligt använda teoretiska och empiriska metoder, även om empirisk analys ju är svårt inom samhällsvetenskaperna.

    • Håller i grund och botten med dig, Olof, om att etikettfrågan inte är viktigAST. Men, samtidigt, etiketter spelar ibland en viktig roll, vare sig vi vill det eller inte. I det här fallet är det ju, om inte annat, anmärkningsvärt att Krugman appellerar till en teori/modell som upphovsmannen själv tagit avstånd från (ÄVEN om detta per se inte avgör frågan om modellens faktiska värde). Inte minst vi som sysslar med teorihistoria vill ju gärna också har ordning och reda på stammar och grenar i våra doktrinhistoriska träd – vilket är en av anledningarna till att jag reagerar negativt på t ex etiketten ”Neo Keynesian” som i mina ögon är en ”misnomer” eftersom de flesta som beskriver sig i dessa termer – som t ex Greg Mankiw – har väldigt lite med Keynes att göra.

      • Klart är att ”ettiketsfrågan” och IS-LM spelade stor roll för John Hicks själv,då han till och med ”bytte namn” för att visa sitt avståndstagande från IS-LM och Neo-classicism.En beundranvärd intellektuell hederlighet tycker jag av en så hyllad och upphöjd ekonom,som ju naturligtvis bara kunnat följt med strömmen, mottagit beröm och skördat lagrarna av vad han gjort tidigare i sitt långa liv.
        ”It must be mentioned,for the record, that on his part that Hicks became uneasy,at a certain point, with his IS-LM formulation.He keep rethinking his history and slowly moving away from
        his so succesful IS-LM model.In the late 1960s/early 1970s,he couragesly critisized it and he explicidly reputdiated it (see Hicks 1975, 1980-81).He went as fare as openly declaring he has ceased to be a neo-classical in his words: ” J.R Hicks is a `neo-classical´ economist,now deceased”.
        What is more, in order to underline his change of mind,he ceased to sign his articles J.R Hicks,instead John Hicks,(in his words: Clearly i need to change my name…John Hicks is a non-neoclassic who is quite disrespectful to his ”uncle” J.R..) John Hicks 1975 p 365
        Luigi L. Pasinetti ”Keynes and the Cambridge Keynesians: A ‘Revolution in Economics’ to be Accomplished” 2007

        • Synnerligen intressant! Träffade Hicks vid några tillfällen
          på 80-talet, men det där med R:et
          kände jag inte till.

          • Ja, det var mkt intressant! Man får f ö inte glömma Hicks viktiga bidrag till mikroteorin. Wikipedia beskriver hans bidrag till ekonomiämnet som följer:

            ”Hicks’s early work as a labour economist culminated in The Theory of Wages (1932, 2nd ed. 1963), still considered standard in the field. He collaborated with R.G.D. Allen in two seminal papers on value theory published in 1934.

            His magnum opus is Value and Capital published in 1939. The book built on ordinal utility and mainstreamed the now-standard distinction between the substitution effect and the income effect for an individual in demand theory for the 2-good case. It generalised the analysis to the case of one good and a composite good, that is, all other goods. It aggregated individuals and businesses through demand and supply across the economy. It anticipated the aggregation problem, most acutely for the stock of capital goods. It introduced general equilibrium theory to an English-speaking audience, refined the theory for dynamic analysis, and for the first time attempted a rigorous statement of stability conditions for general equilibrium. In the course of analysis Hicks formalised comparative statics. In the same year, he also developed the famous ”compensation” criterion called Kaldor-Hicks efficiency for welfare comparisons of alternative public policies or economic states.

            Hicks’s most familiar contribution in macroeconomics was the Hicks-Hansen IS-LM model, which formalised an interpretation of the theory of John Maynard Keynes (see Keynesianism). The model describes the economy as a balance between three commodities: money, consumption and investment. Hicks himself did not embrace the theory as he interpreted it; and, in a paper published in 1980, Hicks asserted that it had omitted some crucial components of Keynes’s arguments, especially those related to uncertainty.”

  3. DId you just call Krugman for a neo-cassical economist?

  4. Ni känner säkert till det, men ordet ”neoklassisk” används ju med väldigt olika innebörd. Det användes väl först som ett begrepp som distanserade nyare teori som framförallt bygger på marginalistiska resonemang från klassikerna. Sedan användes ju begreppet i makroekonomi som den ”neoklassiska syntesen” som beskrev ett försök (av Samuelson och andra) att integrera keynesianism med mikroteori.

    En del nu för tiden använder det som ett paraplybegrepp (inte sällan med negativa konnotationer) för att beskriva ekonomer (av vilka ju endast en liten andel sysslar mad makroekonomi) som avänder sig av en konventionell teoriapparat i botten och/eller inte är explicit kritisk till nationalekonomiämnet i allmänhet.

  5. […] UPDATE 21/03/2013: Steve Keen commented on Krugman’s blog by leaving a comment there, which is also quoted by Lars Syll. […]

  6. Hej Lars,

    nice quotes that you put up there. I found a technical flaw with Krugman’s graph: the savings schedule at full employment cannot be a curve. Savings is a function of income, and saying that you are at full employment leaves you with one possible level of savings. If you are interested in a more detailed discussion visit

    • Thanx. I’ll definitely have a look!

      • I have to agree with you, Dirk!
        In his 1937 paper Hicks actually elaborates four different models:

        1) ”Classical”: M = k*I I = C(i) I = S(i,Y)
        2) Keynes’ ”special” theory: M = L(i) I = C(i) I = S(Y)
        3) Keynes’ ”general” theory: M = L(Y, i) I = C(i) I = S(Y)
        4) The ”generalized general” theory: M = L(Y, i) I =C(i) I = S(i, Y)

        It is obvious from the way Krugman draws his IS-LM curves that he is thinking in terms of model number 4 – and that is not even by Hicks considered a Keynes model (modells 2) and 3)). It’s, as you write, basically a loanable funds model, that belongs in the ”classical” camp and which you find reproduced in most neoclassical textbooks! Hicksian IS-LM? Maybe. Keynes? No way!

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