Question

How are you able to predict the future and explain the past using the IS-LM?

Answer 1

The "investment-savings, liquidity-money," also known as IS-LM model is a Keynesian macroeconomic model that reflects how the market for economic goods (IS) interacts with the money market or loanable funds market (LM). It is displayed as a graph in which the IS and LM curve intersect to show the short-run equilibrium between interest rates and output

When the IS curve slopes downward and to the right on IS-LM graph, indicates the level of investment and consumption is negatively correlated with the interest rate however positively correlated with gross output. Conversely when the LM curve slopes upward, it assumes that the quantity of money demanded is positively correlated with the interest rate and with increases in total income or spending. Thus can provide details on the past and predict the future.

The IS-LM model provides details on the aggregate demand of the economy using the relationship between interest rates and output. In a closed economy, in the goods market, an increase in interest rate decreases aggregate demand, generally investment demand and/or demand for consumer durables. This reduces the output level and results in equating the quantity produced with the quantity demanded. Such condition is equal to the condition that planned investment equals saving.