An Integration of CAPM with IS-LM Analysis into a Unified Theory of Aggregate Demand

A 6-equation aggregate demand model is presented that integrates the capital asset pricing model (CAPM) with an ISLM model to reveal the key role of security risk -- beta -- in the resulting system's stability conditions and policy multipliers. Certain beta ranges ensure both stability and normal signs for policy multipliers. Shifts in the model's aggregate demand curve and slope depend upon the amount of security risk (beta coefficients); a larger beta steepens the curve and reduces (increases) its shift in response to monetary (fiscal) policy. Uncertainty about the true value of beta is shown to reduce the predictability of these shifts. Also examined are several useful extensions of the model to such issues as the term structure of interest rates and the relation among monetary growth, inflation, and equity yields. Beta retains its key role when the model is extended to include a government budget constraint and an aggregate supply function.