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Reconsideration of the IS–LM model and limitations of monetary policy: a Tobin–Minsky model

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  • Toshio Watanabe

    (Fukui Prefectural University)

Abstract

The standard IS–LM model considers all types of financial assets, excluding money, as bonds. We construct a modified IS–LM model to better represent the characteristics of financial markets and investigate the stability of the economy. We present bank behavior explicitly and consider household portfolio preferences through the rate of return on financial assets. We build both static and dynamic models that incorporate the dynamic equation of monetary policy. In our model, an increase in the debt–capital ratio may have a negative impact on the profit rate and bring about the so-called “paradox of debt.” We indicate that factors such as the sensitivity of bank lending to the profit rate and the degree of substitutability between the household’s equity and money have a significant effect on the volatility of the profit rate and equity price. Particularly, the latter may lead to an unstable economy in the long run. We show that it is always possible for the economy to become unstable endogenously. The government and central bank must formulate loan regulations and adopt the appropriate monetary policy to stabilize the economy.

Suggested Citation

  • Toshio Watanabe, 2021. "Reconsideration of the IS–LM model and limitations of monetary policy: a Tobin–Minsky model," Evolutionary and Institutional Economics Review, Springer, vol. 18(1), pages 103-129, April.
    • Handle: RePEc:spr:eaiere:v:18:y:2021:i:1:d:10.1007_s40844-020-00189-8
    DOI: 10.1007/s40844-020-00189-8
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    More about this item

    Keywords

    Financial instability hypothesis; Portfolio selection; Debt–capital ratio; Monetary policy;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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