A Quick Briefing on Keynesian Economics

Although not constructed by Keynes himself, the IS-LM model is the Royal Road to understanding his thought. The vertical axis is the rate of interest, the horizontal is the rate of growth in the economy. The IS line plots a series of equilibrium points for the real economy, the world of traded goods and services. The LM line plots a similar series of equilibrium points for financial markets.



These are not supply and demand curves - to move either line a lot of things have to happen. From the article:

"One Keynesian hypothesis is that a government's deficit spending has an effect similar to that of a lower saving rate or increased private fixed investment, increasing the amount of aggregate demand for national income at each individual interest rate. An increased deficit by the national government shifts the IS curve to the right. This raises the equilibrium interest rate (from r₁ to r₂) and national income (from Y₁ to Y₂), as shown in the graph above.

"The graph indicates one of the major criticisms of deficit spending as a way to stimulate the economy: rising interest rates lead to crowding out – i.e., discouragement – of private fixed investment, which in turn may hurt long-term growth of the supply side (potential output). Keynesians respond that deficit spending may actually "crowd in" (encourage) private fixed investment via the accelerator effect, which helps long-term growth. Further, if government deficits are spent on productive public investment (e.g., infrastructure or public health) that directly and eventually raises potential output."

In other news, Wikipedia has replaced all other sources of knowledge.