Quo Vadis, “Investment” (I) or “Liquidity” (L)?

 

According to Paul Krugman, among other Nobel Laurates, the IS-LM is “a model of several interacting markets.” As he updates, “IS-LM stands for investment-savings, liquidity-money — which will make a lot of sense if you keep reading.” (“IS-LMentary.” NYT blogpost, 2011)

 

Going for Details. With the above said, we quote among other Cambridge macroeconomists from N. Gregory Mankiw (Macroeconomics, 8^th edition).

Investment (I) as Demand for Loans. The quantity of investment goods demanded depends on the interest rate, which measures the cost of the funds used to finance investment. … The firm makes the same investment decision even if it does not have to borrow… but rather uses its own funds. … It slopes downward, because as the interest rate rises, the quantity of investment demanded falls. (pp. 63-4)

Savings (S) as Supply of Loans. [This] equation shows that national saving depends on Y [as fixed by the factors of production] and the fiscal-policy variables G [for governmental expenditures] and T [for tax revenue]. For fixed values of Y, G and T, national saving S also fixed. (pp. 68-9)

Liquidity Preference (L). The underlying reason is that the interest rate is the opportunity cost of holding money…The demand curve … slopes downward because higher interest rates reduce the quantity of real money balances demanded. (pp. 315-6)

Money Supply (M). The money supply M is an exogenous policy variable chosen by a central bank, such as the Federal Reserve. (p. 315)

 

For the Rest of Us. Now, it’s high time we appreciated the so-claimed “IS-LMentary.”

Fact 1. S and M are residents alien without a voting right in Cambridge. In gentler words, they are “exogenous to the model” and not allowed to freely vary “endogenous of the model.”

Fact 2. All that matters when in Cambridge are investment (I) and liquidity preference (L), both of which represent the opportunity benefit in return for “costing the opportunity” also called “the interest rate.” Incidentally, “the interest rate” is meant by John M. Keynes to be “the complex of rates of interest” (1936, p.28) with no regard to IS-LM.     

On the sidewalk. “Demand” for a benefit faces a cost, real or virtual (imaginary), and vice versa.  

 

The Choice of Benefit. Which would we trade off “the interest rate” for, investment (I) or preferred liquidity, also called “money,” in hands (L)?

A Clue. Irving Fisher, Paul Samuelson and William Nordhaus in one voice (异口同声, yì kǒu tóngshēng in pinyin) comment, “Money is useless until we get rid of it” (e.g. Samuelson and Nordhaus, Economics 19^th ed. p. 458).

In fine. Let us choose “investment goods” as the benefit, no matter what “the opportunity cost.” Thus, we have investment (I) only out of all the IS-LM.

             Then on, what follows a round of “monetary policy”? Well, that’s a piece of cake: ΔM→ ΔI→ ΔY≡ ΔI+ ΔC. Why bother with “several interacting markets”?

             After all, money is usually a veil, and yet might as needed become a promoter. On the flipside, a promoter rarely plays the role of a player. Well, Don King has never fought a single round in the ring.

 

Boney M. - Brown Girl in the Ring