Interest Rate Determination in India: Empirical Evidence on Fiscal Deficit--Interest Rate Linkages and Financial Crowding Out
AbstractControlling for capital flows using the high-frequency macro data of a financially deregulated regime, this paper examines whether there is any evidence of the fiscal deficit determining the interest rate in the context of India. The period of analysis is FY 2006-07 (April) to FY 2011 (April). Contrary to the debates in policy circles, the paper finds that an increase in the fiscal deficit does not cause a rise in interest rates. Using the asymmetric vector autoregressive model, the paper establishes that the interest rate is affected by changes in the reserve currency, expected inflation, and volatility in capital flows, but not by the fiscal deficit. This result has significant policy implications for interest rate determination in India, especially since the central bank has cited the high fiscal deficit as the prime reason for leaving the rates unchanged in all of its recent policy announcements. The paper analyzes both long- and short-term interest rates to determine the occurrence of financial crowding out, and finds that the fiscal deficit does not appear to be causing either shorts and longs. However, a reverse causality is detected, from interest rates to deficits.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_744.
Date of creation: Dec 2012
Date of revision:
Contact details of provider:
Web page: http://www.levyinstitute.org
Fiscal Deficit; Asymmetric Vector Autoregressive Model; Financial Crowding Out;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H6 - Public Economics - - National Budget, Deficit, and Debt
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Laurence J. Kotlikoff, 1985.
"Taxation and Savings - A Neoclassical Perspective,"
NBER Working Papers
1302, National Bureau of Economic Research, Inc.
- Vinod, Hrishikesh D., 2006. "Maximum entropy ensembles for time series inference in economics," Journal of Asian Economics, Elsevier, vol. 17(6), pages 955-978, December.
- Balkan, Erol M. & Erol, Umit, 1995. "Country Risk and International Portfolio Diversification," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 48(1), pages 1-12.
- Johansen, S., 1991.
"Determination of Cointegration Rank in the Presence of a Linear Trend,"
Papers, Helsinki - Department of Economics
76a, Helsinki - Department of Economics.
- Johansen, Soren, 1992. "Determination of Cointegration Rank in the Presence of a Linear Trend," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 383-97, August.
- Zivot, Eric & Andrews, Donald W K, 1992.
"Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis,"
Journal of Business & Economic Statistics, American Statistical Association,
American Statistical Association, vol. 10(3), pages 251-70, July.
- Zivot, Eric & Andrews, Donald W K, 2002. "Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(1), pages 25-44, January.
- Tom Doan, . "ZIVOT: RATS procedure to perform Zivot-Andrews Unit Root Test," Statistical Software Components RTS00236, Boston College Department of Economics.
- Eric Zivot & Donald W.K. Andrews, 1990. "Further Evidence on the Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Cowles Foundation Discussion Papers 944, Cowles Foundation for Research in Economics, Yale University.
- Ostrosky, Anthony, 1979. "An Empirical Analysis of the 'Crowding Out' Effect of Fiscal Policy in the United States and Canada: Comment and Extensions," Kyklos, Wiley Blackwell, vol. 32(4), pages 813-16.
- Correia-Nunes, Jose & Stemitsiotis, Loukas, 1995. "Budget Deficit and Interest Rates: Is There a Link? International Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 57(4), pages 425-49, November.
- Gibson, William E, 1970. "Price Expectations Effects on Interest Rates," Journal of Finance, American Finance Association, vol. 25(1), pages 19-34, March.
- Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
- Willem H. Buiter, 1990. "Principles of Budgetary and Financial Policy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262524139, December.
- Culver, Sarah E & Papell, David H, 1997. "Is There a Unit Root in the Inflation Rate? Evidence from Sequential Break and Panel Data Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 12(4), pages 435-44, July-Aug..
- Cebula, Richard J., 1990. "Government Borrowing and Interest Rates in the United States: An Empirical AnaÂ¬lysis Using the IS-LM Framework," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 43(2-3), pages 159-164.
- Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
- Caines, P. E. & Keng, C. W. & Sethi, S. P., 1981. "Causality analysis and multivariate Autoregressive modelling with an application to supermarket sales analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 3(1), pages 267-298, November.
- Hsiao, Cheng, 1981. "Autoregressive modelling and money-income causality detection," Journal of Monetary Economics, Elsevier, vol. 7(1), pages 85-106.
- Barro, Robert J., 1974.
"Are Government Bonds Net Wealth?,"
3451399, Harvard University Department of Economics.
- Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
- Makin, John H, 1983. "Real Interest, Money Surprises, Anticipated Inflation and Fiscal Deficits," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 374-84, August.
- Laurence Ball & Stephen G. Cecchetti, 1990. "Inflation and Uncertainty at Long and Short Horizons," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 215-254.
- Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
- Pradhan, B. K. & Ratha, D. K. & Sarma, Atul, 1990. "Complementarity between public and private investment in India," Journal of Development Economics, Elsevier, vol. 33(1), pages 101-116, July.
- Toda, Hiro Y. & Yamamoto, Taku, 1995. "Statistical inference in vector autoregressions with possibly integrated processes," Journal of Econometrics, Elsevier, vol. 66(1-2), pages 225-250.
- Sargent, Thomas J, 1969. "Commodity Price Expectations and the Interest Rate," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 83(1), pages 127-40, February.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie-Celeste Edwards).
If references are entirely missing, you can add them using this form.