Home > The Economics Profession > On Krugman’s reading list

On Krugman’s reading list

from Lars Syll

As we all know Paul Krugman is very fond of referring to and defending the old and dear IS-LM model.

John Hicks, the man who invented it in his 1937 Econometrica review of Keynes’ General TheoryMr. Keynes and the ‘Classics’. A Suggested Interpretation – returned to it in an article in 1980 – IS-LM: an explanation – in Journal of Post Keynesian Economics. Self-critically he wrote:

I accordingly conclude that the only way in which IS-LM analysis usefully survives — as anything more than a classroom gadget, to be superseded, later on, by something better – is in application to a particular kind of causal analysis, where the use of equilibrium methods, even a drastic use of equilibrium methods, is not inappropriate. I have deliberately interpreted the equilibrium concept, to be used in such analysis, in a very stringent manner (some would say a pedantic manner) not because I want to tell the applied economist, who uses such methods, that he is in fact committing himself to anything which must appear to him to be so ridiculous, but because I want to ask him to try to assure himself that the divergences between reality and the theoretical model, which he is using to explain it, are no more than divergences which he is entitled to overlook. I am quite prepared to believe that there are cases where he is entitled to overlook them. But the issue is one which needs to be faced in each case.  

When one turns to questions of policy, looking toward the future instead of the past, the use of equilibrium methods is still more suspect. For one cannot prescribe policy without considering at least the possibility that policy may be changed. There can be no change of policy if everything is to go on as expected-if the economy is to remain in what (however approximately) may be regarded as its existing equilibrium. It may be hoped that, after the change in policy, the economy will somehow, at some time in the future, settle into what may be regarded, in the same sense, as a new equilibrium; but there must necessarily be a stage before that equilibrium is reached …

I have paid no attention, in this article, to another weakness of IS-LM analysis, of which I am fully aware; for it is a weakness which it shares with General Theory itself. It is well known that in later developments of Keynesian theory, the long-term rate of interest (which does figure, excessively, in Keynes’ own presentation and is presumably represented by the r of the diagram) has been taken down a peg from the position it appeared to occupy in Keynes. We now know that it is not enough to think of the rate of interest as the single link between the financial and industrial sectors of the economy; for that really implies that a borrower can borrow as much as he likes at the rate of interest charged, no attention being paid to the security offered. As soon as one attends to questions of security, and to the financial intermediation that arises out of them, it becomes apparent that the dichotomy between the two curves of the IS-LM diagram must not be pressed too hard.

Back in 1937 John Hicks said that he was building a model of John Maynard Keynes’ General Theory. He wasn’t.

What Hicks acknowledges in 1980 is basically that his original review totally ignored the very core of Keynes’ theory – uncertainty. In doing this he actually turned the train of macroeconomics on the wrong tracks for decades. It’s about time that neoclassical economists – as Krugman, Mankiw, or what have you – set the record straight and stop promoting something that the creator himself admits was a total failure. Why not study the real thing itself – General Theory – in full and without looking the other way when it comes to non-ergodicity and uncertainty?

  1. October 4, 2012 at 2:50 pm

    Very good article.

  2. October 4, 2012 at 3:12 pm

    To provide some background to the Hicks article in the JPKE.

    I originally published an article about Keynes’s finance motive — which in 1937 Keynes added to his other liquidity preference motives (transactions, precautionary, speculative motives) , I showed that adding this finance motive required that Hicks’s IS curve and LM curves to be interdependent — and thus when the IS curve shifted so would the LM curve.
    Hicks and I then discussed this when we met several times.

    When I first started to think about the ergodic vs. nonergodic dischotomy, I sent to Hicks some preliminary drafts of articles I would be writing about nonergodic processes. Then John and I meet several times to discuss this matter further and I finally convinced him to write the article — which I published in the Journal of Post Keynesian Economics– in which he renounces the ISLM apparatus. Hicks then wrote me a letter in which he thought the word nonergodic was wonderful and said he wanted to lable his approach to macroeconomics as nonergodic!

    Paul Davidson

  3. October 4, 2012 at 3:55 pm

    VERY interesting indeed Paul!

  4. paolo leon
    October 6, 2012 at 10:04 pm

    I’d like to remind Davidson that Hicks also gave some weight to what I call the ” Macroeconomic foundations of microeconomics”

    • October 7, 2012 at 9:19 pm

      what time frame are ou talking about Peolo? If it is before 1981 then this is the old Hicks who renounced all his previous “nobel prize” wining analysis.

  5. kharris
    October 23, 2012 at 1:19 pm

    “It’s about time that neoclassical economists – as Krugman, Mankiw, or what have you – set the record straight and stop promoting something that the creator himself admits was a total failure.”

    There is a failure of logic here. Krugman may or may not believe that IS-LM is a true reflection of what Keynes wrote or thought, but the point to using IS-LM is that it serves a useful purpose. Hicks was not a god. He was an early proponent of Keynes, and later on thought he had left something critical out of his effort to create a simplified model of Keynes’ thought. Krugman is not enthralled to Hicks. To argue that he is seems a bit like a Monty Python treatment of the followers of Marx – nothing matters more than comprehending Marx, and you sir have miscomprehended him utterly!!!

    Krugman’s point, as he has made it over and over again, is that the IS-LM model offers a very useful way of thinking about the economy in some circumstances. It’s not a idol. It’s a tool and a tool that works. If you want to argue that the tool doesn’t work, fell free, but you simply don’t have any ground to stand on in requiring that Krugman “stop promoting” IS-LM, because Krugman makes IS-LM work.

    “It’s about time that” we take other peoples’ views as they are offered, rather than as caricatures apt for ridicule.

  6. March 23, 2013 at 11:04 am

    I’m commenting on this because the variation on it dated 23 Mach 2013 has somehow lost its “Leave a Reply” section. Here kharris seems to be missing the point that Sir John Hicks was man enough to admit himself that he was wrong. Nothing ridiculous about that.

    I agree with Lars: read Keynes’s General Theory, and compare that with what various interpreters of IS/LM say of it on the web. My pennyworth is that Keynes was writing about EMPLOYMENT, interest and money, which doesn’t enter into IS/LM as originally conceived and variously construed. Reflect on the GT chapter 7 – “The meaning of savings and investment”, wherefrom stock market type “investment” makes sense only as a particularly destructive type of “savings”: more robbing Peter to pay Paulin such a way that Peter’s Liquidity becomes available to Paul as a cashe of Money.

    To bring reality into IS/LM one needs to interpret the L as the labour resulting from investment and the M as the maintenance done to save our real wealth from deterioration.

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