How does the IS-LM model help economists in the day to day analysis of the economy? There are just too many assumptions that are not there in the real world.

  • 2
    IS-LM is not used in day to day analysis. In fact very few models are. – denesp Nov 2 '16 at 20:34
  • I voted to close because while this is a perfectly legitimate question, it is not suitable for this site as any decent answer would be too long. See e.g. this 2000 book: IS-LM and Modern Macroeconomics. – Kenny LJ Nov 5 '16 at 10:33
  • A decent answer could still be reasonably succinct here. Many questions on this SE could discussed at length but a short answer + suggestion for further reading is suitable. I think this is one. @KennyLJ – Jamzy Nov 7 '16 at 0:59
  • @denesp That is not true- the IS-LM and Mundell-Fleming type model is used by many central banks and organizations, as are DSGE models. – ChinG Aug 8 at 17:56
  • @ChinG X "type model" and X "model" are not the same. I am very happy to learn that central banks use more sophisticated models and not base IS-LM. – denesp Aug 8 at 22:22

Two vies on IS-LM, Keynesian and Monetarist, analyses extreme situations of the economy. It provides comparative-static equilibrium condition. It ignores time-lags. It doesn't consider effects of changes in aggregate demand on output and prices.

Keynesian version assumes price level to be constant and inflation ignored. Neoclassical version considers full-employment and so price level is result of nominal money supply and output is exogenous.

The best economic models make useful predictions with as little complexity as possible -- in other words, they make assumptions that aren't "true" in the real world, but make predictions that nevertheless turn out to be true.

For instance, advocates of the day-to-day use of the IS-LM model such as Paul Krugman point to the analysis of liquidity traps as an important case where its users have proved to be right where many other analysts have made bad predictions.

From "What I Mean When I Talk About IS-LM (Wonkish)":

Those of us who understood IS-LM and took it seriously declared in advance — in late 2008 and early 2009 — that big deficits and huge increases in the monetary base would lead neither to soaring interest rates nor to soaring inflation. This was very much not what many influential people were saying: there were widespread forecasts of soaring rates and soaring inflation. Later, there were many people denying that austerity would have negative effects on output.

He provides a more detailed explanation of an IS-LM analysis of liquidity traps (and a few other insights that the model provides).

ADVANTAGES 1.LARGE ECONOMY 2.NATIONAL LEVEL PROBLEMS 3.CALCYLATE NATIONAL INCOME 4.LESS ASSUMPTIONS 5.WORKING OF ECONOMIC MARKET

DISADVANTAGES 1.IGNORANCE OF INDIVIDUAL UNITS 2.INCOMPLETE RECORDS 3.LESS EXACT RESULTS 4.NO INDIVIDUAL APOROACH

                           BY VIPUL M SADRANI
New contributor
VIPUL M SADRANI is a new contributor to this site. Take care in asking for clarification, commenting, and answering. Check out our Code of Conduct.

Your Answer

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

Not the answer you're looking for? Browse other questions tagged or ask your own question.