A Note on Keynesian Models Used in Standard Textbooks

This article shows that there is a methodological problem in the traditional IS-LM model. If production cannot be sufficiently adjusted downwards, there is no uniform interest rate that simultaneously clears the money and goods markets. An extension of the credit market in the tradition of the loanable funds theory resolves this contradiction and yields a coherent mechanism for crisis dynamics and policy transmission. In this expanded model, the interest rate is determined by the credit market whereby the total supply of credit results from household savings and the credit supply of banks and the demand for credit is due to investment demand and the demand for liquidity. This methodological approach facilitates the explanation of crisis dynamics, as involuntary inventory investment generates liquidity problems and disequilibria in the goods market lead to imbalances in the financial markets.