IS-LM Is Ignored for a Reason

Lots of talk by Tyler Cowen and Scott Sumner arguing against the IS-LM framework, and Brad DeLong and Paul Krugman defending it. I remember how important it was as an ungraduate, and then when I was a TA for undergrads at Northwestern, found it odd that macro emphasized this framework that was totally ignored in graduate school.

The IS-LM framework was an intellectual dead end. It started with all sorts of optimism about how it could generate useful predictions and guidance on how to steer the economy, but basically deflected focus from the little things that make an economy work: property rights, good incentives. When the economy underperformed, the answer was always more goverment spending. When the economy was working well, they presumed it would keep on working no matter what, so we increased all sorts of social programs that hurt families and created an ever-larger patronage portion of the economy.

Then, the 70's. Empirically we had stagflation, which shouldn't happen. The model was internally inconsistent as the Lucas Critique showed the IS-LM implied the modeler knew about different relationships than the economic agents in the models, which is always attractive to those in the vanguard (thus, the popularity of Behavioral economics, based on correcting the biases of others). When Chris Sims showed that an atheoretical, simple, vector autoregression outperformed the fancy macro models built upon IS-LM logic, the ghost was up. No one wrote dissertations extending the IS-LM framework anymore. When I was in grad school it simply was never discussed except when working on undergraduate expositions.

Here's Krugman describing his situation having to teach graduate macro a few years ago:

This spring I have a new assignment: to teach Macroeconomics I for graduate students. Ordinarily this course is taught by someone who specializes in macroeconomics; and whatever topics my popular writings may cover, my professional specialties are international trade and finance, not general macroeconomic theory. However, MIT has a temporary staffing problem, which is itself revealing of the current state of macro, and I have been called in to fill the gap.

Here's the problem: Macro I is a quarter course, which is supposed to cover the "workhorse" models of the field - the standard approaches that everyone is supposed to know, the models that underlie discussion at, say, the Fed, Treasury, and the IMF. In particular, it is supposed to provide an overview of such items as the IS-LM model of monetary and fiscal policy, the AS-AD approach to short-run versus long-run analysis, and so on. By the standards of modern macro theory, this is crude and simplistic stuff, so you might think that any trained macroeconomist could teach it. But it turns out that that isn't true.

You see, younger macroeconomists - say, those under 40 or so - by and large don't know this stuff. Their teachers regarded such constructs as the IS-LM model as too ad hoc, too simplistic, even to be worth teaching - after all, they could not serve as the basis for a dissertation. Now our younger macro people are certainly very smart, and could learn the material in order to teach it - but they would find it strange, even repugnant.

So, he admits 1) he knows as much about macro as a cardiologist knows about cancer, and 2) no younger economists care to know about the IS-LM model. Of course his conclusion is that this is a travesty, not the more reasonable inference that his prejudices have probably led him to like the IS-LM model more than warranted.

Here's a tip. When a new paradigm is introduced, and it generates many honors, books, and large-scale-collaberative models, and then after 40 years is found uninteresting by young graduate students who don't have a dog in the fight, this is a sign it has been a good-faith mistake. Best to move on. All the IS-LM model predicts is that with massive fiscal or monetary stimulus there will be a short run effect, but you don't need the IS-LM for that (eg, WW3 will increase output). And like any short run stimulus, that shouldn't be the focus of economists, any more than a psychologist should recommend drinking beer to get over your problems (you'll feel better in an hour!).