Asset stocks and flows in macroeconomic theory: Resolving the ambiguities in the general IS-LM model

Abstract

In this paper we have critically examined the macroeconomic model developed by Benavie as a generalization of the beginning-of-period model of Tobin and of Patinkin's end-of-period approach. We have focused our attention on the ambiguous effects on income of government spending changes and tax changes that result from this model. Our conclusions are twofold. First, with respect to the effects of government spending on equilibrium income, we find that, if the demand function for money is decreasing in the interest rate, then the effect of government spending onY is unambiguously positive for any value ofφ. The ambiguity discovered by Benavie is a result of his implicit assumption that money has the characteristics of a Giffen good. Second, in the case of the tax ambiguity, we find the source of the problem to be in the particular formulation of Benavie's asset demand functions. Benavie specifies his asset demand functions in such a way that tax changes impinge directly on these demands. If both stock and flow demands depend upon gross income and not taxes, then there isno ambiguity with respect to tax changes regardless of the value ofφ. However, if both stock and flow demands depend upon disposable income, and hence taxes, the effect of tax changes on equilibrium income becomes ambiguous, but again independently of the value ofφ.