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3.3 The IS–LM Model for a Closed Economy

The orthodox Keynesian model which has had such an important bearing on

the development of macroeconomics, right through to the present day, initially

stemmed from Hicks’s (1937) famous article entitled ‘Mr. Keynes and

the “Classics”: A Suggested Interpretation’. This Hicksian model was subsequently

elaborated upon by Modigliani (1944) and was popularized in the

USA by Hansen (1949, 1953). Indeed, over the next half-century the Hicksian

IS–LM model became the established model for macroeconomic theorizing

and it had a tremendous influence on the direction of macroeconomic policy

right up to the mid-1960s.

It is assumed that most readers will at least be familiar with the derivation

of the IS–LM model, so that in what follows initially we merely review the

main features of the model for a closed economy, in particular the way the

model integrates real and monetary factors in determining aggregate demand

The orthodox Keynesian school 103

and therefore the level of output and employment. Those readers who are

unfamiliar with the derivation of the model (or the extension of the model to

an open economy) should refer to any standard macroeconomics text, such as

Dornbusch et al. (2004). We begin our review with the goods market and the

IS curve.