Is-Lm
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- Category: Politics: Economics
- Date Submitted: 11/27/2010 09:39 AM
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: A working model
Aug 11th 2005 : From The Economist print edition
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Is the world experiencing excess saving or excess liquidity?
WHEN The Economist's economics editor studied macroeconomics in the 1970s, the basic model for understanding swings in demand was the so-called IS-LM framework, invented by Sir John Hicks in 1937 as an interpretation of Keynes's “General Theory”. In recent years it has gone out of fashion, dismissed as too simplistic. That is a pity, for not only does the model seem more relevant than ever today, but it also casts useful light on why bond yields are so low.
America's Federal Reserve raised short-term interest rates again this week, to 3.5%, its tenth increase since June 2004. Yet over that period, long-term bond yields have fallen to historically low levels. Indeed, virtually everywhere around the globe real bond yields are unusually low. The most popular explanation is that there is a global glut of savings, which has driven yields down. However, while some parts of the world, notably Asia, may save more than they need to, it is not obvious that the world as a whole is doing so. Over the past couple of years, global saving has risen as a share of GDP, but so too has investment. By definition, global saving must equal global investment; what really matter are ex ante, desired rates of saving and investment which may have caused bond yields to decline. An alternative explanation, preferred by some economists, is that bond prices, like other asset prices, have simply been pushed up by excess liquidity (ie, yields have been pushed down).
The IS-LM model helps us to understand these two opposing theories. Originally devised for a single closed economy, it can today be more realistically applied to the global economy. Its main virtue is that it brings together both the real and the financial parts of the economy. The IS (investment/saving) curve represents equilibrium in product markets, showing combinations of...
Aug 11th 2005 : From The Economist print edition
|
|
|
|
Is the world experiencing excess saving or excess liquidity?
WHEN The Economist's economics editor studied macroeconomics in the 1970s, the basic model for understanding swings in demand was the so-called IS-LM framework, invented by Sir John Hicks in 1937 as an interpretation of Keynes's “General Theory”. In recent years it has gone out of fashion, dismissed as too simplistic. That is a pity, for not only does the model seem more relevant than ever today, but it also casts useful light on why bond yields are so low.
America's Federal Reserve raised short-term interest rates again this week, to 3.5%, its tenth increase since June 2004. Yet over that period, long-term bond yields have fallen to historically low levels. Indeed, virtually everywhere around the globe real bond yields are unusually low. The most popular explanation is that there is a global glut of savings, which has driven yields down. However, while some parts of the world, notably Asia, may save more than they need to, it is not obvious that the world as a whole is doing so. Over the past couple of years, global saving has risen as a share of GDP, but so too has investment. By definition, global saving must equal global investment; what really matter are ex ante, desired rates of saving and investment which may have caused bond yields to decline. An alternative explanation, preferred by some economists, is that bond prices, like other asset prices, have simply been pushed up by excess liquidity (ie, yields have been pushed down).
The IS-LM model helps us to understand these two opposing theories. Originally devised for a single closed economy, it can today be more realistically applied to the global economy. Its main virtue is that it brings together both the real and the financial parts of the economy. The IS (investment/saving) curve represents equilibrium in product markets, showing combinations of...