Procrustean Art of Backtracking: “IS-LM of Reverse Causation”

 

To begin, we quote from The Conscientious Liberal:

So, the first thing you need to know is that there are multiple correct ways of explaining IS-LM. That’s because it’s a model of several interacting markets, and you can enter from multiple directions, any one of which is a valid starting point.

My favorite of these approaches is to think of IS-LM as a way to reconcile two seemingly incompatible views about what determines interest rates. One view says that the interest rate is determined by the supply of and demand for savings – the “loanable funds” approach. The other says that the interest rate is determined by the tradeoff between bonds, which pay interest, and money, which doesn’t, but which you can use for transactions and therefore has special value due to its liquidity – the “liquidity preference” approach. (Yes, some money-like things pay interest, but normally not as much as less liquid assets.)

How can both views be true? Because we are at minimum talking about *two* variables, not one  – GDP as well as the interest rate. And the adjustment of GDP is what makes both loanable funds and liquidity preference hold at the same time. (NYT blogpost, 2011)

Probably, he does not realize that he causelessly rebels against his Master of Masters who disrespects in “so many words” “the ‘loanable funds’ approach” (1936). Apparently, at any rate, he is “talking” to other macroeconomists and their innocent students while hating like “W” all the residents alien. Well, he suspects one of his archenemies to be ante mortem “intellectually dishonest.”

 

             Now, the rest of us can in just a few words put the “several interacting markets” down below the ground.

             First, he says the interest rate is determined by “the supply of and demand for the loanable funds.” More than clearly he means the rate is subject to his defining the supply and demand. He has “the interest rate” in hands already. How can the interest rate “vary” afterwards?

             Second, Sir John R. Hicks, one of his St. John’s, famously suggests that money demand be a constant fraction of the nominal GDP which is somehow determined and given already. How can GDP “vary” afterwards?

             To be true, “GDP as well as the interest rate” as parameters are residents alien in IS-LMentary. The two of them if in the several interacting markets, “Freeze, please!” An “exogenous parameter’ is by naming “incompatible” with an “endogenous variable.” Get in the first place the names correct (正名, zhengming)!

 

Externality to innocent bystanders. “Hmm, macroeconomists as usual handily customize feet to the bed. So “convenient for their sake” only!