Conclusions

The main contributions of the IS/LM model to our understanding of Keynes's economic theory is that: (1) it provides a clear and logical explan­ation of why a capitalist economy can exist in a stable high-unemployment equilibrium state, even if only in the short run; and (2) it provides the frame­work for a narrative, as opposed to a formal model, of the causes of secular stagnation.

are always stable is a virtue. For all other purposes and for the other four models in The General Theory, the always-stable IS/LM model embodies a serious misunderstanding of Keynes's theory. Its widespread acceptance among economists as the one and only model in The General Theory led the economics profession to completely miss the destructive dynamic processes that occupy almost half of its pages. The IS/LM model shows that financial markets always help counteract negative shocks to AD by lowering interest rates and can never exacerbate them, and that financial markets can never initiate financial instability. Indeed, the late 1920s and 1930s financial boom and subsequent collapse in the USA is inexplicable within the confines of the model designated as Keynes's legacy. The fact that the post-WWII economics profession came to accept this idyllic view of the nature of lightly regulated financial markets, later embodied in "efficient financial markets" theory, helped financial corporations in their successful efforts to disassemble the strict regulation of financial markets imposed in the midst of the 1930s depression. This radical financial market deregulation was a major cause of the global financial crisis that erupted in 2007-2008. Moreover, when embedded in the standard AS/AD model, the IS/LM model demonstrates that deflation always raises AD and lowers unemployment, a proposition Keynes aggressively attacked in chapters 2 and 19 of The General Theory.

In The General Theory, Keynes constructed a theory that could be used to explain the historical record of real-world capitalism. This record contains periods of relatively stable economic evolution in "normal times," long periods of mostly rapid growth as in the "glorious" nineteenth century, normal business cycles, bouts of extreme instability in "interesting times" that are endogenously created, endogenous financial bubbles and crashes, and secular stagnation or prolonged depressions that can threaten social and political stability. These were explained by Keynes in the five models he developed in The General Theory to support his belief that capitalism had to be replaced by Liberal Socialism.

The main problem with the IS/LM model, then, is not just that it can be legitimately claimed to reflect or embody only a subset of the important criticisms of modern capitalism Keynes presented in The General Theory. The problem, rather, is the widespread belief among economists that the IS/LM model is all that Keynes bequeathed to the profession in his magnum opus, and therefore it is the sole argument he made against clas­sical theory. This means that his support for Liberal Socialism has an inad­equate logical foundation.

Prior to the Great Depression, the overwhelming majority of US economists taught that a stable high-unemployment equilibrium was impossible in a free-market economy. Even in the depths of the depres­sion, when it was obvious to almost everyone that market forces alone could not restore prosperity to the country, the economics profession still relied on a variant of classical theory (Colander and Landreth 1996).¹¹ This

A digression 289 changed dramatically as a result of the outstanding performance of the economy under government planning during WWII and the success of the new model of big-government capitalism that underpinned the "Golden Age" of post-WWII capitalism that ended in the 1970s. What turned out to be a one-generation phase in the historical trajectory of modern capitalism was interpreted by most economists to be the permanent state of modern capitalism. The near-universal acceptance of the IS/LM model as the sole legacy of Keynes's work helped put his radical economic theory and his support of Liberal Socialism into the dustbin of history.

The IS/LM model cleansed Keynes's work of many of its most serious criticisms of the nature of capitalism, including both capitalism's poten­tial for secular stagnation and its destructive disequilibrium processes, including wage and price deflation, and the "insane" behavior of lightly regulated financial markets. When the profession accepted and propagated the view that the IS/LM model incorporated all of Keynes's important contributions in The General Theory, the reasons for his per­sistent commitment to Liberal Socialism got lost in translation.