Abstract:

This case is intended to introduce students to the

fundamentals of macroeconomic management
using the IS-LM model. The name of this model
originates from the basic equilibrium conditions of
income determination: investment (I) must equal
saving (S); money demanded (L) must equal money
supplied (M). General equilibrium is a situation of
simultaneous equilibrium in both the goods market
(IS) and the money market (LM). The IS-LM model
was developed in 1937 by Nobel laureate Sir John
Hicks, who intended it as a graphical
representation of the ideas presented by Keynes
during the Great Depression of the 1930s in his
famous book, The General Theory of Employment,
Interest, and Money. Since Hicks, several
economists have refined the IS-LM model, and
have been widely applied in understanding cyclical
fluctuations in economic activity and
macroeconomic policy. The recession that began
in December 2007 in the U. S. grew steadily worse,
and the unemployment rate increased
dramatically. During the financial crisis of 2008,
U.S stock prices plunged. Investors feared that a
depression was around the corner because of the
breakdown of the financial sector. The result was
that the world witnessed the largest and sharpest
drop in global economic activity since the Great
Depression of the 1930s. In 2009, most developed
economies found themselves in deep recession.
However, India, one of the prominent emerging
economies of the world, was resilient to the sharp
decline in national output. The Indian stock market
crashed in 2008, resulting in a destructive impact
on household wealth, business confidence, credit
crunch, and a decline in consumer spending and
private investment spending.

The global crisis impacted India’s financial and

real sectors due to demand shock. Private demand
and external demand were quickly affected and
further resulted in a reduction in gross domestic
output. The real GDP growth rate declined to 6.7
percent in 2008-09 from 9 percent in 2007-08. The
Reserve Bank of India, the Central Bank, and
government responded with easy monetary and
fiscal policies that in turn had their effects on real
output, interest rate, budget deficit, the general
price level, and on crowding out of private
investment.

The case offers students several opportunities for

analysis. They can begin by analyzing the impact
of the global financial crisis on aggregate demand
in India and identify the factors that shifted the IS
curve. The case contains information and data on
various components of aggregate demand and data
on the real and financial sectors. It has sufficient
details about the fiscal and monetary policy
measures taken during the crisis period in India.
Finally, students can analyze the effects of
massive policy (both fiscal and monetary)
responses using the IS-LM framework. The case
has been developed using secondary data and
information. The case enables the students to
analyze the dynamics of the closed economy IS-LM
model using the data on the Indian economy.

 Q1.Analyze how the financial and real sectors

are affected by a demand shock.
 Q2.Analyze how the IS-LM model can be
applied to understand how an economy copes
with disturbances (or, shocks) in the short run?
 Q3.Analyze the influence of monetary and
fiscal policies on the money market and the
goods market?
 Q4.Discuss policy responses and understand
the related dynamics such as increase in fiscal
deficit, rise in general price level, rise in
interest rate, crowding out of private
investment etc.?