ISLM

IS-LM is a macroeconomic framework used to analyze short-run equilibrium in a closed economy by jointly considering the goods market and the money market. It was developed by John Hicks in 1937 as a formal interpretation of John Maynard Keynes's General Theory.

The IS curve represents all combinations of output (Y) and the interest rate (i) for which the goods market is in equilibrium, that is where planned expenditure equals output. It is derived from the national income identity in equilibrium between investment and saving. The curve is downward sloping: higher real interest rates reduce investment, which lowers aggregate demand and output.

The LM curve represents all combinations of Y and i for which the money market is in equilibrium, given money supply M and price level P. Since money demand L(Y,i) typically rises with income and falls with the interest rate, a rise in income raises the demand for money and, with a fixed money stock, pushes the interest rate up; thus LM is upward sloping.

Equilibrium occurs at the intersection of IS and LM, giving the short-run level of output and the interest rate, with prices assumed fixed. The model is used to illustrate the effects of fiscal policy (shifting IS through changes in G or taxes) and monetary policy (shifting LM through changes in M). Fiscal expansion tends to raise Y and i, potentially crowding out investment. Monetary expansion lowers i and raises Y.

An open-economy version, IS-LM-BP, adds the balance of payments and capital mobility, showing how exchange rates influence policy effectiveness. The model has limitations: it is static, assumes fixed prices in the short run, depends on assumed forms of consumption, investment, and money demand, and abstracts from expectations and dynamics.