On the consistent specification of asset markets in macroeconomic models

The standard IS LM model has been criticized in recent years for an alleged neglect of portfolio balance and government financing constraints. Examination of the structure of the bond market implicit in a simple IS LM model shows that these criticisms are misdirected. We find that portfolio adding-up restrictions do not provide additional comparative static information in an IS LM context and may be harmful if imposed on the model. In addition, the IS LM framework is seen to be complete and logically consistent even in the absence of explicit financing constraints.