ABSTRACT
The primary contribution of the IS/LM model is that it helps explain why it is possible to have a high-unemployment equilibrium. This chapter shows that John Maynard Keynes believed both of the propositions were the opposite of the truth, a fact that is rarely if ever mentioned when the IS/LM model is described in undergraduate text books or even in standard advanced treatments of Keynes’s economic theory. One implication of Keynes’s theory of disequilibrium dynamics is that comparative-static analysis, which must assume stabilizing out-of-equilibrium dynamics, is an illegitimate analytical procedure in a fully Keynesian model. The chapter looks at Keynes’s model as a system of augmented IS/LM curves that shift over time in response to exogenous shocks and their own endogenous dynamic forces. The complete economic model would be composed of the structural equations of the expanded IS/LM model combined with equations that explain how expectations and confidence are formed.
