IS-LM Paradigm in Macroeconomics: A Survey and Evaluation

Abstract

This paper analyzes many serious defects existing in traditional aggregate demand/aggregate supply paradigm based on IS-LM model. Those defects cause the situation that IS-LM model declines gradually, but it is still not dead, and continuously revives through modification. This paper distinguishes from rounds of modification on traditional aggregate demand/aggregate supply paradigm. The first round of modification was just introducing the dynamic ad hoc IS-LM model of rational expectation which started from the end of 1970s and the beginning of 1980s. Because the micro-foundation problems are not solved and the rational expectation carries out extreme judgment on monetary neutrality and ineffectiveness of macroeconomic policy, the first modification fails to realize big success. The second round of modification is just happening; through introducing rational expectation and New Phillips Curve (NPC), the powerful improvement has been made in micro-foundation, dynamic form, and monetary policy rules, and the model is called IS-LM/ MP-NPC model. This paper also points out some limitations which are not solved in the second modification.