The Keynesian Revolution and IS-LM: From Enigma to Conundrum

Abstract

This paper attempts to place the IS-LM model in the framework of the Keynesian revolution, a matter still subject to conjecture and debate. Substantive questions relating to this issue are posed, and suggestions are made regarding how to resolve them – rather than attempts to answer them per-se by reference to the conventional wisdom. Cognitive and operational levels of analysis are specified, with focus upon questions relating to continuity, cardinality, conflict and consensus regarding the relationship between the model and the Keynesian revolution. The plasticity, metamorphosis, dynamization and canonization of the model are then dealt with, again, in the context of its relationship to the Keynesian revolution.

Comment on Warren Young’s Paper

M June Flanders

Warren Young has given us a thorough review of the IS-LM apparatus. I like what he has done.

I use the term apparatus advisedly. I do not call it a theory, nor does Young. It is, rather, a “device”, which is what Hicks himself called it when he developed it in 1937.

He has done us a great service by rescuing Hicks’s French revision of the apparatus in 1945 from the anonymity caused by the unilingual bias of the economics profession. It is highly significant that Hicks himself revised his earlier view that the General Theory was simply a special case of a more general construct – that is, the “Economics of Depression”.¹

My reservations about IS-LM are twofold.

First, it is a charming apparatus, but hardly a theory of how an economy behaves. In 1937 Hicks himself referred to his construction as a “little apparatus”, though by 1945 he was developing it into a dynamic model, albeit a fairly simple and general one. It may be a useful tool to permit scholars of opposing schools to highlight their differences in terms of a common language, regarding the slopes of the several curves, for example. But it ignores the richness of what Young has called the other Cambridge interpretation of the General Theory, and certainly ignores the widely neglected, but in my view enormously important and elegant, interpretation of Shackle, for example, stressing the crucial role of uncertainty in the income-determination model, especially, but not exclusively, in the demand for money.

Hicks, in his discussion in the brief paper, was more aware of the subtleties of interpretation than the subsequent mechanistic applications and interpretations of the “apparatus” recognized. For, as he said, and as Klein (1952) noted, he singled out the liquidity preference function as the hallmark of the Keynesian Weltanschauung – which is consistent with Shackle’s view of Keynes (1967, 1983).

This implies criticism of the disregard for Hicks’s caveats, not only because it trivializes the General Theory, as suggested, but also because I find the apparatus a very dubious, even pernicious, pedagogical tool. Students who have been taught to toss about curves or lines of opposite slope and to zero in on their intersection do so with alacrity and frequently fail to comprehend that these curves do not represent simple behavioral functions, like supply and demand. I have observed this among college sophomores and advanced PhD candidates as well. As a teaching device, McKenna’s old textbook (1965), for example, with separate but linked diagrams, gives a much more accessible picture of what in fact is going on – or believed to be going on.²

Young speaks admiringly, as well he should, of later applications and uses of the construct, including that of Klein. But on rereading Klein, after 50 years, I remain convinced that the significant point Klein was making was that the full employment S=I might occur only at negative interest rates (85).³

Young mentions the “caveats” in his 1937 paper, “which were somewhat overlooked by those who later transformed his ‘little apparatus’ (1937a, p. 156) into ‘the core’ of modern macroeconomics or at least of its textbooks. I agree strongly with the thrust of that comment. Hicks’s article, as I remember it, specifically states that it is a way of looking at various theories (it is not a theory) so that each is a special case of a general statement”. … in Sheila Dow’s opinion, “the growth of mathematical formalism meant a significant divergence from Keynes’s approach”.

In short, I maintain that the purpose of the Hicks paper was to argue that Keynes and the Classics represented special cases of a general theory, and that this was transformed into a pedagogical device of possibly useful and frequently dangerous value. The true impact of Hicks’s brilliant insights into macroeconomics was revealed, in my view, only in his Value and Capital, in 1939, but that is another story.