ABSTRACT
The investment/saving (IS) curve describes positions in which the product market is in equilibrium. The liquidity-money (LM) curve describes positions in which the asset markets (money and bond markets) clear. This chapter explains the IS-LM system which puts the two subsystems together in order to describe a nearly general equilibrium in which the product, money and bond markets clear simultaneously. This allows economists to make precise statements about how monetary policy, fiscal policy, and various shocks that change the underlying parameters of the model affect the equilibrium values of key endogenous variables. In the basic IS-LM model, fiscal policy operates through the IS curve and monetary policy operates through the LM curve. The IS-LM system is an elaboration of the Keynesian model. If the asset markets clear instantaneously, the economy always is on its LM curve.
