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Monetary and Fiscal Policy in a DSGE Model of India

Author

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  • Levine, Paul

    (University of Surrey)

  • Pearlman, Joseph

    (London Metropolitan University)

Abstract

We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explict target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies.The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions. It is calibrated using India and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules. A comparison with a fixed exchange rate regime is ade. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy. These policy prescriptions contrast with the monetary-fiscal policy stance of the Indian authorities.

Suggested Citation

  • Levine, Paul & Pearlman, Joseph, 2011. "Monetary and Fiscal Policy in a DSGE Model of India," Working Papers 11/96, National Institute of Public Finance and Policy.
  • Handle: RePEc:npf:wpaper:11/96
    Note: Working Paper 96, 2011
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    Cited by:

    1. Ano Sujithan, Kuhanathan, 2014. "Le système financier indien à l'épreuve de la crise," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/14810 edited by Avouyi-Dovi, Sanvi, December.
    2. Parantap Basu & Shesadri Banerjee, 2015. "Effect of Quantitative Easing on the Indian Economy: A Dynamic Stochastic General Equilibrium Perspective," CEGAP Working Papers 2015_03, Durham University Business School.
    3. Parantap Basu & Shesadri Banerjee, 2015. "Role of IST and TFP Shocks in Business Cycle Fluctuations: The Case of India," CEGAP Working Papers 2015_04, Durham University Business School.

    More about this item

    Keywords

    Monetary policy ; Emerging economies ; Fiscal and monetary rules ; Financial accelerator ; Liability dollarization;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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