R codes for IS and LM curve

IS_LM_Functions.R

# IS curve equation
# y = output; c = marginal propensity to consume; alpha = 1/(1-c) A = autonomous component;
# b = Senstivity to interest rates; i = interest rates
# I = I.0 - b*i (investment equation)
# y = alpha*A - alpha*b*i

IS.curve <- function(c, A, b, i)
{ 
  y = (1/(1-c))*A - (1/(1-c))*b*i
  return(y)
}


# LM curve equation
# Usual definitions follow from above; k = sensitivity of transactions demand for money to change in income
# h = senstivity of speculative demand for money to change in income; MS = real money supply in the economy 
# ((nominal money)/(prices)
# y = MS/k - (h/k)*i

LM.curve <- function(ms, h, k, i)
{
  y = ms/k + (h/k)*i
  return(y)
}

# Function to calculate the point of intersection of the IS and LM curves

Intersect <- function(c, A, b, ms, h, k ,i) # Using cramers rule to solve a system of simultaneous equations
{
a1 <- (1/(1-c)) * b
b1 <- 1
c1 <- (1/(1-c)) * A
a2 <- - (h / k)
b2 <- 1
c2 <- ms/k
stopifnot(a1 * b2 - b1 * a2 != 0) # We need to make sure that the determinant is non-zero.
return(list(
            x = (b2 * c1 - b1 * c2)/(a1 * b2 - b1 * a2),
            y = (a1 * c2 - a2 * c1)/(a1 * b2 - b1 * a2)
            )
        ) 
}

# IS curve plotting

autonomous.component <- 100
mpc <- 0.5
b <- 0.75
i <- c(1,2,3,4,5,6,7,8,9,10)
y.is <- IS.curve(mpc,autonomous.component, b, i)

# LM curve plotting

ms <- 143
h <- 1.8
k <- 0.8
y.lm <- LM.curve(ms, h, k, i)

# Effect of government spending or tax cut of any other form of fiscal policy

autonomous.component.gov <- 102  # Say the government spending increased by 2 units
y.is.gov <- IS.curve(mpc,autonomous.component.gov, b, i)

# Effect of increasing money supply by the central bank (or monetary policy)

ms.mon <- 145 # money supply increased by 2 units
y.lm.mon <- LM.curve(ms.mon, h, k, i)

# Finding the point of intersection of the IS-LM curves

intersect <- Intersect(mpc, autonomous.component, b, ms, h, k ,i)
intersect.gov <- Intersect(mpc, autonomous.component.gov , b, ms, h, k ,i)
intersect.mon <- Intersect(mpc, autonomous.component , b, ms.mon , h, k ,i)
intersect.mon.gov <- Intersect(mpc, autonomous.component.gov , b, ms.mon , h, k ,i)


# IS-LM framework

plot(y.is,i, xlim = c(180,205), ylim = c(-1,10), type ="l", 
main = "Fiscal and Monetary policy together", xlab = "Output(Y)", 
ylab = "Interest rates(I)", col = "red")

lines(y.lm, i, type = "l", col = "green")
lines(y.is.gov, i, type = "l", lty = 2, col = "red")
lines(y.lm.mon, i , type ="l", lty = 2, col = "green")
legend("bottomright", c("IS", "LM") , cex=0.5, col=c("red", "green"), lwd=2, bty="n")

lines(c(-1, intersect$y, intersect$y), c(intersect$x, intersect$x, -1), lty=2, col='black')
lines(c(-1, intersect.gov$y, intersect.gov$y), c(intersect.gov$x, intersect.gov$x, -1), lty=2, col='black')
lines(c(-1, intersect.mon$y, intersect.mon$y), c(intersect.mon$x, intersect.mon$x, -1), lty=2, col='black')
lines(c(-1, intersect.mon.gov$y, intersect.mon.gov$y), 
c(intersect.mon.gov$x, intersect.mon.gov$x, -1), lty=2, col='black')