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 *...