...against fictions and other tall tales

Tuesday, 8 March 2011

Memories of IS/LM

Here's my first penciled depiction of the diagram made famous by John Hicks. I still like the model's clarity. However, one of its major flaws is it holds that growth-inducing government deficits lead to increases in interest rates. We'll deal with this issue in a later blog entry, but for now, I should specify that the proposition linking government deficits to higher interest rates is not applicable to countries with a fiat monetary system and a floating exchange rate (e.g. US, Canada, Australia, Japan, UK, etc). More precisely, this is the case because the short-term interest rate in these countries is not set by the market: it is under the near-total control of the country's central bank. For more information, I recommend the following article by Bill Mitchell.

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