How Well Does the IS-LM Model Fit in a Developing Economy: The Case of India

Abstract

The IS-LM model, as a vehicle for policy analysis, has a substantial influence on the policy makers and academicians. Like the developed countries, the IS-LM framework remains important for students to learn in the developing countries because of the benefits it offers in clarifying their thinking about the implications for practical policy issues. The main purpose of this study is to examine how well the dynamic properties of the estimated model of India match to the theoretical predictions of IS-LM model. The purpose is accomplished through Structural Vector Autoregressive (SVAR) model by estimating variance decompositions and impulse response functions. Our model explicitly accounts for the variables included in core macroeconomic models developed in the Keynesian flavour and specifies identification scheme, which capture some features of the developing economies in general. Our findings support the advocates of the IS-LM model most often compared to critics of the model.

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