“What was lost with IS-LM” is an article by David Laidler and Rodger Backhouse. The authors discuss the IS-LM model in great detail and explain the ideas that they perceive to have gotten lost from the discipline of macroeconomics when this particular model became dominant in the in the twentieth century. The authors contend that some of the idea losses were only temporary while others were, in fact, long lasting. According to the authors, the IS-LM model which is comparable to the General Theory (the IS-LM model is partially derived from the General Theory) caused the disruption of crucial and promising developments in the macroeconomics field that was still rapidly developing. This took place in the 1930’s and across the 1940’s. The authors argue that had some of these developments had been allowed to mature and had they not aborted by the IS-LM model, they would have eventually evolved and become extremely useful and relevant theories that could have been used to explain macroeconomic policies and fluctuations.
Laidler and Backhouse the go on to explain four distinctive types of losses that they attribute to the dominance of the IS-LM model. The four losses are in one or another derived from the Keynes’s analytic methods, specifically the strict equilibrium character in both the IS-LM construction as well as the General Theory.
The first loss that Laidler and Backhouse attribute to the IS-LM model is dynamic analysis. This is due to the fact that the IS-LM is essentially a single-period model and does not, therefore, allow for dynamic analysis. Backhouse and Laidler claim that IS-LM is a static model. The variables in the model are dated, and even the lags are not modeled formally (Backhouse and Laidler 7).
The second loss that Laidler and Backhouse attribute to the IS-LM model is the intertemporal choice and expectations. According to Laidler and Backhouse, decisions about saving and investing are concerned with the allocation or distribution of resources over time, the concern the timing of both production and consumption. However, according to Laidler and Backhouse, “this inter-temporal dimension of aggregate demand was neglected in IS-LM analysis and also in the General Theory” (Backhouse and Laidler 11).
The third loss that the two attribute to the IS-LM model is policy regimes. The authors argue that the IS-LM model has led to the loss of nation’s policy regimes. A single period model means that policy is essentially a one-time affair. Therefore, in this case, the problem of construction a regime that results in the achievement of optimal results over time fails to arise. Laidler and Backhouse write that when it is formulated and expressed in the terms of IS-LM, the significance of the time element in policy design was lost (Backhouse and Laidler 14). However, the two are fast to emphasize that the point is not that the policy has to take into account the dynamic effects and lags when it comes to the stability of the response of the policy measures. The main point however is that economic activity essentially takes place over several years over a specific amount of time; that various shocks are actually unpredictable. The point is also that monetary stability over time including the stability of the price level is in real sense very vital for the efficient and smooth working of a market economy. All these factors are seemingly ignored in the IS-LM model (Backhouse and Laidler 14).
The fourth loss that Backhouse and Laidler attribute to the IS-LM mold regards inter-temporal coordination failures. Once again, this concept is rendered irrelevant due the one-period nature of the IS-LM model. The author’s then go on to give explicit details about how this came about and how the view of the allocation of resources has been configured over time and how this crucial idea of inter-temporal coordination failure has become lost over time.
The significance of all these losses is then discussed by Backhouse and Laidler. It is particularly argued that the dimension loss when it comes to economic activity and everything that was drained away during the incorporation of the IS-LM model is only temporary. However, some of these losses are in actual sense long term. This has been discovered after it has become technically possible to construct models whereby the inter-temporal choice is key, where expectations are forward-looking, where policy changes actually have a dynamic effect on the economy and where it is natural to subject policy problems to analysis that is based on choice among several alternative regimes (Backhouse and Laidler 20). In the end, Backhouse and Laidler write that is quite hard to portray macroeconomics development after the year 1936 as one that involves a steady progress “at the cost of no significant losses” (Backhouse and Laidler 22). According to Backhouse and Laidler, the best description would be the formalization of this sub-discipline of economics had several desirable gains but at the same time, it encompassed regrettable losses. What emerges from this is that is quite important for practitioners of economics to retain familiarity with older ideas and ways of thinking even as new ideas continue to emerge. During the IS-LM model era, failure to track already existing ideas was detrimental to the discipline and left a negative effect that is still felt today.
Works Cited
Backhouse, Roger E., and David Laidler. What was lost with IS-LM. No. 2003-6. Research Report, Department of Economics, University of Western Ontario, 2003.
Kriesler, Peter, and John Nevile. "IS–LM and macroeconomics after Keynes. “Money, Macroeconomics and Keynes: Essays in Honour of Victoria Chick 1 (2002): 103-114.
