Posted by: Dirk | August 28, 2019

A spreadsheet version of the IS/MY model (alternative to IS/LM model)

I have recently completed a tiny spreadsheet version of the ISMY model. The model was developed in 2014 and represents an alternative to the IS/LM model. I have a small page filled with content related to the model here. Probably I should look for a different name of the model, like Modern Macroeconomics Theory Model (MMTM) or something of that sort since it is based on Modern Monetary Theory (MMT) foundations. Anyway, here is a screenshot:

Bildschirmfoto 2019-08-28 um 10.25.26

This simple model fits today’s world very well since I got rid of:

  • money market equilibrium – because the central bank supplies the reserves the banking system demands. Otherwise you get a catastrophic collapse of the financial system.
  • downward-sloping investment curve – because the idea that lower interest rates stimulate private investment is basically dead now.
  • upward-sloping LM curve – because central banks keep interest rates constant whatever public debt / public deficit / public spending is.

What I introduce is the sectoral balances equation as used by Wynne Godley, so that in the model you can show that:

  • public deficits are private surpluses
  • in a boom, private sector net financial savings decrease
  • in a crisis, private sector net financial savings increase
  • public deficits are mainly driven by changes in tax revenue
  • full employment can be reached by increasing public spending
  • more public spending allows private sector to deleverage

I hope that this model will be taken up by more colleagues as it is very clear now that the IS/LM model “does not work”. If you make it more realistic by saying that investment does not depend on the rate of interest (vertical IS curve) and that the central bank determines the interest rate (horizontal LM curve), then you will have wasted 3-4 lectures to explain the goods market (IS curve) and the money market (LM curve) only to conclude that both do not matter in practice. It is only a small step from there to conclude that teaching the IS/LM model is a waste of time. You might just say that “demand determines supply, which determines employment” and that “government spending and private investment, which both do not depend on the rate of interest, increase demand”. Your students will easily get it and you save 3-4 lectures for something else, like my IS/MY model.

(If you have any questions please do not hesitate to email me.)

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