A Comparison of Keynes’s General Theory Model of IS – LM in Chapter 21 and the 1934 Draft Copy of the General Theory: Keynes Made a Major Conceptual Improvement

Abstract

Keynes made major improvements in the manner in which he presented his IS-LM model in the General Theory in February 1936 when compared to the 1934 Draft copy of June–July Keynes’s improvements were with respect to the specification of the Consumption function, marginal propensity to consume, and investment multiplier and removing the variable, W, which stood for the impact of the "the state of the News", which actually measured the change in the weight of the argument (evidence).

Keynes correctly substituted “expectation(confidence)” in the 1934 draft, instead of using “the state of the news”. This was still not correct as Keynes is still incorporating and mixing up expectational and actual variables in the same set of equations. Keynes got it correct in the General Theory when he defined uncertainty as an inverse function of the weight of the argument and confidence as a negative function of uncertainty, which makes confidence a positive function of the weight of the argument, in the General Theory. The reader should note that Keynes never defined the weight of the argument, V(a/h)=w, until page 315 in chapter 26 of the A Treatise on Probability.

Keynes‘s comments to his students about the role of mathematical equations in macroeconomics has been severely and badly misinterpreted to mean that no formal mathematical analysis of macroeconomics was possible. Keynes was always aware of the fact that no mathematical model alone was capable of representing the macro economy in its entirety. He spent pages 300-303 of the General Theory listing the types of important analysis that were not considered or taken into account in the IS-LM model itself. However, the IS-LM model,while being presented on pp.298-299 of the General Theory as being “…valuable in introducing order and method into our enquiry., "however," presents a deceptive simplicity, if we forget that the three elements (a), (b) and (c) are themselves partly dependent on the complicating factors (2), (3), (4) and (5) which we have not yet considered…” (Keynes,1936,p.298).

All of macroeconomic history needs to be rewritten in order to incorporate Keynes’s use of an explicit IS-LM model in chapter 21 of the General Theory.