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Fiscal Deficit, Capital Formation, and Crowding Out : Evidence from India

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  • Lekha S. Chakraborty

Abstract

Theoretical literature identifies two variants of crowding out in an economy–real and financial. The real (direct) crowding out occurs when the increase in public investment displaces private capital formation broadly on a dollar-for-dollar basis, irrespective of the mode of financing the fiscal deficit. The financial crowding out is the phenomenon of partial loss of private capital formation, due to the increase in the interest rates emanating from the pre-emption of real and financial resources by the government through bond-financing of fiscal deficit. The paper analysed the real and financial crowding out in India during 1970-71 to 2002-03. Using asymmetric vector autoregressive model, the paper finds no real crowding out between public (in particular, infrastructure) and private investment; rather complementarity is observed between the two. The dynamics of financial crowding out is captured through the dual transmission mechanism via real rate of interest; that is, whether private capital formation is interest rate sensitive and in turn whether the rise in real rate of interest is induced by fiscal deficit. The study found empirical evidence for the former, but not the latter, reinforcing no financial crowding out in India. [NIPFP WP 43]

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  • Lekha S. Chakraborty, 2007. "Fiscal Deficit, Capital Formation, and Crowding Out : Evidence from India," Working Papers id:837, eSocialSciences.
  • Handle: RePEc:ess:wpaper:id:837
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    1. Jagadish Prasad Sahu & Sitakanta Panda, 2012. "Is private investment being crowded out in India? Some fresh evidence," Economics Bulletin, AccessEcon, vol. 32(2), pages 1125-1132.
    2. Khan, Rana Ejaz Ali & Gill, Abid Rashid, 2009. "Crowding Out Effect of Public Borrowing: A Case of Pakistan," MPRA Paper 16292, University Library of Munich, Germany.
    3. Asamoah, Lawrence Adu, 2016. "Fiscal Policy and Lending Rate Nexus in Ghana," MPRA Paper 80209, University Library of Munich, Germany.
    4. Syed Ammad & Qazi Masood Ahmed, 2014. "Dynamic Effects of Energy Sector Public Investment on Sectoral Economic Growth: Experience from Pakistan Economy," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 53(4), pages 403-421.
    5. Pankaj SINHA & Sushant GUPTA & Nakul RANDEV, 2011. "Modeling & Forecasting Of Macro-Economic Variables Of India: Before, During & After Recession," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 6(1(15)/ Sp), pages 43-60.

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    More about this item

    Keywords

    fiscal deficit; real crowding out; financial crowding out; capital formation; bond-financing; private investment; public investment; Economics; Public finance; Indian Economy;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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