Abstract for: The Endogenous Money IS-LM Model of the Debt Money System (Part I) – A Paradigm Shift in Macroeconomics
The IS-LM analysis has played a central role in the history of economic thoughts. For example, in order to analyze the causes of the Great Depression, Mankiw (2016) presented (1) Spending hypothesis (shocks to IS curve) as proposed by Keynes and (2) Money hypothesis (shocks to LM curve) as proposed by Friedman and Schwartz (1963), and then rejects the latter by applying them in the IS-LM model. This paper presents a system dynamics model of the Keynesian short-run IS-LM analysis and examine if one of the two seemingly contrasting hypotheses should really be dismissed. Our simulation analyses indicate the standard short-run IS-LM model itself needs to be rejected as a reliable model of the economy operating under the current fractional reserve banking system. We then develop an alternative endogenous money IS-LM model by integrating the two hypotheses as a dynamic feedback process. It is demonstrated that the model captures the unexplained behaviors of the Great Depression under the (3) Endogenous Money Spending hypothesis, which turns out to be consistent with the original analysis by Fisher (1945) who emphasized the role of deposit contraction. A paradigm shift to the endogenous money analysis is emphasized.