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Is the Government Deficit in India Still Relevant for Stabilisation?

  • Khundrakpam, Jeevan K.
  • Goyal, Rajan

This paper employing bounds test to cointegration analysis (Pesaran et al, 2001) revisited the linkages between real output, price and money and studied the impact of government deficit on money in India for the period 1951-52 to 2006-07. It finds that money and real output cause price both in the short as well as in the long run while money is neutral to output. Further, evidence shows that government deficit leads to incremental reserve money creation even though the Reserve Bank financing of Government deficit almost ceased to exist during most part of the current decade. It argues that Government deficit by influencing the level of sterilisation impacts the accretion of net foreign assets to RBI balance sheet and, therefore, continues to be a key factor causing incremental reserve money creation and overall expansion in money supply. Given the finding that money leads to inflation, government deficit, therefore, remains relevant for stabilisation.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 50905.

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Date of creation: Aug 2009
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Publication status: Published in Reserve Bank of India Occasional Papers No. 3, Winter.29(2009): pp. 1-21
Handle: RePEc:pra:mprapa:50905
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  1. 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.
  2. Jeroen J.M. Kremers & Neil R. Ericsson & Juan J. Dolado, 1992. "The power of cointegration tests," International Finance Discussion Papers 431, Board of Governors of the Federal Reserve System (U.S.).
  3. Gregory, Allan W. & Hansen, Bruce E., 1996. "Residual-based tests for cointegration in models with regime shifts," Journal of Econometrics, Elsevier, vol. 70(1), pages 99-126, January.
  4. M. Hashem Pesaran & Yongcheol Shin & Richard J. Smith, 2001. "Bounds testing approaches to the analysis of level relationships," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 16(3), pages 289-326.
  5. Moosa, Imad A., 1997. "Testing the long-run neutrality of money in a developing economy: the case of India," Journal of Development Economics, Elsevier, vol. 53(1), pages 139-155, June.
  6. Bijan B. Aghevli & Mohsin S. Khan, 1978. "Government Deficits and the Inflationary Process in Developing Countries (Déficits publics et processus inflationniste dans les pays en développement) (Los déficit públicos y el proceso inflaciona," IMF Staff Papers, Palgrave Macmillan, vol. 25(3), pages 383-416, September.
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