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Is Fiscal Policy Contracyclical in India: An Empirical Analysis

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Author Info
Chakraborty, Pinaki
Chakraborty, Lekha S

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Abstract

The paper empirically examines the validity of Keynesian philosophy of contracyclical variation in fiscal policy to the macroeconomic activity in India. The macroeconomic activity is proxied by ‘output gap’ a concept defined to estimate the index of economic activity. Applying Johansen’s Full Information Maximum Likelihood test of cointegration, it was found that there exists a long run, stable relationship between fiscal policy stance and macroeconomic activity. Further, the causality detection in asymmetric vector autoregression model revealed that there exists feedback mechanism between fiscal policy stance and output gap, which reinforces the Keynesian theory that fiscal stance is contracyclical in nature. The policy implication of these results points to the fallacy of rule-based fiscal policy to contain fiscal deficit, based on the neo-classical assumption that fiscal deficit has detrimental effects through financial crowding out. The results reinforced the role of fiscal deficit not as an evil but as an instrument of short run demand management and also the significance of pump priming.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 7604.

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Date of creation: 2006
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Handle: RePEc:pra:mprapa:7604

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Related research
Keywords: Fiscal stance; Output gap; Contracyclical fiscal policy; Stationarity; Cointegration; Asymmetric vector autoregression.;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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  1. Ahking, Francis W. & Miller, Stephen M., 1985. "The relationship between government deficits, money growthm and inflation," Journal of Macroeconomics, Elsevier, vol. 7(4), pages 447-467. [Downloadable!] (restricted)
  2. Peter C.B. Phillips & Pierre Perron, 1986. "Testing for a Unit Root in Time Series Regression," Cowles Foundation Discussion Papers 795R, Cowles Foundation, Yale University, revised Sep 1987. [Downloadable!]
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  3. Hirotugu Akaike, 1969. "Fitting autoregressive models for prediction," Annals of the Institute of Statistical Mathematics, Springer, vol. 21(1), pages 243-247, December. [Downloadable!] (restricted)
  4. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  5. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
  6. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  7. Keating, John W., 2000. "Macroeconomic Modeling with Asymmetric Vector Autoregressions," Journal of Macroeconomics, Elsevier, vol. 22(1), pages 1-28, January. [Downloadable!] (restricted)
  8. Hsiao, Cheng, 1981. "Autoregressive modelling and money-income causality detection," Journal of Monetary Economics, Elsevier, vol. 7(1), pages 85-106. [Downloadable!] (restricted)
  9. Richard D. Haas & Peter S. Heller & Ahsan S. Mansur, 1986. "A Review of the Fiscal Impulse Measure," IMF Occasional Papers 44, International Monetary Fund.
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