Hoisted from Comments: The Tribal Dislike of John Hicks and IS-LM

Nick Rowe writes:

The Tribal Dislike of John Hicks and IS-LM: History of Economic Thought Edition: Yours is a very different interpretation of ISLM from the usual one.

The usual one is that LM ("the money market" (yeuch!)) determines r, given Y; and IS (the goods market) determines Y, given r.

Yours is that LM (the output market) determines Y, given r; and IS (the bond market) determines r, given Y.

Even allowing for the "everything is determined simultaneously by both curves" truism, there is a genuine difference here.

I like yours better. Mainly because with 3 goods in a monetary exchange economy there are two markets: a market where money is traded for output; and a market where money is traded for bonds. The standard IS story is one where bonds seem to be traded for output, so bonds, not money, are the medium of exchange.

Care to expand on the differences between your interpretation and the standard one? I think this stuff matters.

In the standard framework if planned S > planned I then spending is less than income and… nobody ever asks where the income that isn't spent goes. The answer seems to me to be that people begin holding money as a savings vehicle if there aren't enough bonds to go around--and that money is no longer there to be part of the transactions money supply. The money stock is then both (a) the determinant through the quantity theory of the interest rate i and (b) the channel through which planned S > planned I puts downward pressure on Y. It seems to me that you are already confused.

By contrast, saying that the flow-of-funds S=I at the current level of PY determines the interest rate, and then people take a look at their money balances and adjust their flow of spending as a result is less confusing. You don't have to get into planned vs. actual, ex ante vs. ex post, or any of that stuff.