The IS-LM model has become a major element in policy analysis and point of reference in understanding macroeconomic events in an economy. For instance, the monetarists argue that when the LM curve is almost vertical, the economy is operating under a classical range. Moreover, when the IS curve takes an interest-elastic position, as a result of increased money supply which leads to reduced interest rate and increased income level, the economy is said to be in a near-full employment state.
The model further explains the application of the fiscal policy and monetary policy in different business cycles and their efficacy. However, there has been continuing debates between economists supporting the Keynesian view versus the monetarist’s view. The Keynesians argue that the fiscal policy surpasses the effects of changes in interest rates and has a direct effect on aggregate demand resulting from changes in tax rates and public expenditure which affects investment and consumption. For this reason, the Keynesians claim that the fiscal policy is more effective than the monetary policy. Monetarists, on the other hand, express their doubt on the effectiveness of the fiscal policy if the supply of money does not vary.
The IS-LM model has two major limitations;