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Restoring Macroeconomic Stability through Fiscal Adjustment: a Real–Financial CGE Analysis for India

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  • C. W. M. Naastepad

Abstract

Developing‐country attempts to regain macroeconomic stability through fiscal adjustment are often unsuccessful in reducing inflation and balance‐of‐payments (BoP) disequilibrium. This paper examines why this may be so in the light of India's experience with stabilization in response to the BoP crisis in 1991. It does so using a novel real–financial computable general‐equilibrium model. Focusing on credit rather than money, the model goes beyond earlier modeling approaches by (1) incorporating credit rationing, (2) recognizing the dual role of credit for working capital and investment, and (3) allowing for switches between credit‐constrained, capacity‐constrained, and demand‐constrained, regimes. The simulations indicate that the macroeconomic effects of monetized deficit reduction differ widely depending on the mode of financing and on initial conditions in real and financial markets. Whenever fiscal reform leads to a squeeze on available working capital credit, deficit reduction will lead to only a limited inflation decline and a modest BoP improvement.

Suggested Citation

  • C. W. M. Naastepad, 2003. "Restoring Macroeconomic Stability through Fiscal Adjustment: a Real–Financial CGE Analysis for India," Review of Development Economics, Wiley Blackwell, vol. 7(3), pages 445-461, August.
    • Handle: RePEc:bla:rdevec:v:7:y:2003:i:3:p:445-461
    DOI: 10.1111/1467-9361.00202
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    References listed on IDEAS

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    9. Sen, Kunal & Roy, Tirthankar & Krishnan, R. & Mundlay, Arundhati, 1996. "A flow of funds model for India and its implications," Journal of Policy Modeling, Elsevier, vol. 18(5), pages 469-494, October.
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    11. C. W. M. Naastepad, 2001. "The Macro‐Economic Effects of Directed Credit Policies: A Real‐Financial CGE Evaluation for India," Development and Change, International Institute of Social Studies, vol. 32(3), pages 491-520, June.
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    Cited by:

    1. Mallick, Sushanta K., 2005. "Tight credit policy versus currency depreciation: Simulations from a trade and inflation model of India," Journal of Policy Modeling, Elsevier, vol. 27(5), pages 611-627, July.
    2. André, Francisco J. & Cardenete, M. Alejandro, 2009. "Defining efficient policies in a general equilibrium model: a multi-objective approach," Socio-Economic Planning Sciences, Elsevier, vol. 43(3), pages 192-200, September.
    3. Francisco Andre & M. Alejandro Cardenete, 2009. "Designing Efficient Subsidy Policies in a Regional Economy: A Multicriteria Decision-Making (MCDM)-Computable General Equilibrium (CGE) Approach," Regional Studies, Taylor & Francis Journals, vol. 43(8), pages 1035-1046.

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