The IYLM Model Is a Pre-General Theory Model That Is Equivalent to Keynes’s mid 1934 Draft Copy Version

Abstract

Keynes ‘s General Theory has two separate, but interrelated models. Keynes called these models the D-Z and IS-LP(LM) models. The D-Z model deals only with expected results and outcomes. Expectations, uncertainty and confidence are dealt with by Keynes through his analysis of D=D1+D2 and Z=Z1 +Z2, where D1 measures expected consumption expenditures by consumers and D2 measures expected investment expenditures by businessmen based on Keynes’s Marginal Efficiency of Capital (mec) concept.

This model is built mathematically in chapters 20 and 21 of the General Theory after having been introduced briefly in chapter 3. Chapter 20 deals with the Goods and Labor markets. Keynes incorporates the Money market into the D-Z model on pp. 304-306 of the General Theory. The IS-LM(LP) model is an entirely separate model that deals with the actual or realized results of an economy. It is presented in its final form on pages 298-303 of the General Theory. Its form is Y=C+I, where C equals actual consumption expenditures and I equals actual investment expenditures. I has absolutely nothing to do with expectations or expected mec results. Keynes did not publish his December, 1933, four equation model presented in December 4th to his students or the very similar mid 1934 first draft copy of the General Theory because these models mixed up realized variables with expected variables.

The IYLM model of O’Donnell and Rogers (2016; Cambridge Journal of Economics) presents a model that is very similar to the earlier four equation models that Keynes realized were a conceptual breakthrough, but which were badly flawed mathematically and technically. Their IYLM model mixes up realized and expected results and does not make any sense mathematically because you can’t add realized consumption and expected investment to equal realized aggregate demand as done by O’Donnell and Rogers (2016). Their main error was their inability to recognize the interrelated, but separate nature of Keynes’s two models.