IS-LM Stability Revisited: Samuelson was Right, Modigliani was Wrong

In Hicks’s IS-LM model, when the marginal propensity to spend is greater than one, the Keynesian multiplier is negative and the IS has a positive slope. Keynes deemed this case as totally unstable. Further literature, from Modigliani (1944) through our days, including Varian (1977) and Sargent (1987), determined that in this special case the IS-LM model is stable when the LM slope is greater than the IS.In line with Samuelson (1941), this article shows that in this case the model is stable when the IS slope is greater than the LM slope. However, in this stable case, the model does not carry a useful economic meaning. Firstly, the equilibrium values of production and interest rates are negative. Secondly, since the Keynesian multiplier is negative, an expansion of demand reduces output.

Keywords

Economic Thinking, Macroeconomic theory, IS-LM model.

JEL Classification

E11, B22