The IS-LM model is still one of the main models with which to introduce macroeconomics. In its static form it comprises an IS curve, which denotes real income and interest rate combinations which lead to equilibrium in the goods market, and an LM curve, which denotes real income and interest rate combinations which lead to equilibrium in the money market. Overall equilibrium is established where the IS curve cuts the LM curve. It is then common to consider comparative statics, which involves changing one or more exogenous variables or changing some parameter of the model. Very rarely do we observe any detailed analysis of what happens out of equilibrium, and yet this is what we are more likely to be observing around us. In this chapter we will reconsider this model from a dynamic point of view, beginning with a simple linear version and extending the analysis to more complex formulations and nonlinear specifications.

In the first two sections we consider the goods market and then the goods market along with the money market using simple discrete dynamic models of the macroeconomy. In these formulations we introduce dynamics through the goods market equilibrium condition. Rather than assume aggregate income equals aggregate expenditure in the same period, we make the assumption that income in period t is equal to total expenditure in the previous period.