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Is Fiscal Policy Contracyclical in India: An Empirical Analysis

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  • Chakraborty, Pinaki
  • Chakraborty, Lekha S

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.

Suggested Citation

  • Chakraborty, Pinaki & Chakraborty, Lekha S, 2006. "Is Fiscal Policy Contracyclical in India: An Empirical Analysis," MPRA Paper 7604, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:7604
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    File URL: https://mpra.ub.uni-muenchen.de/7604/1/MPRA_paper_7604.pdf
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    References listed on IDEAS

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    1. 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.
    2. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
    3. 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.
    4. Phillips, P C B, 1987. "Time Series Regression with a Unit Root," Econometrica, Econometric Society, vol. 55(2), pages 277-301, March.
    5. Charles Adams & David T. Coe, 1990. "A Systems Approach to Estimating the Natural Rate of Unemployment and Potential Output for the United States," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 232-293, June.
    6. Litterman, Robert B, 1986. "Forecasting with Bayesian Vector Autoregressions-Five Years of Experience," Journal of Business & Economic Statistics, American Statistical Association, vol. 4(1), pages 25-38, January.
    7. Phillips, P C B, 1987. "Time Series Regression with a Unit Root," Econometrica, Econometric Society, vol. 55(2), pages 277-301, March.
    8. Hirotugu Akaike, 1969. "Fitting autoregressive models for prediction," Annals of the Institute of Statistical Mathematics, Springer;The Institute of Statistical Mathematics, vol. 21(1), pages 243-247, December.
    9. Keating, John W., 2000. "Macroeconomic Modeling with Asymmetric Vector Autoregressions," Journal of Macroeconomics, Elsevier, vol. 22(1), pages 1-28, January.
    10. Hsiao, Cheng, 1981. "Autoregressive modelling and money-income causality detection," Journal of Monetary Economics, Elsevier, vol. 7(1), pages 85-106.
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    Citations

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    Cited by:

    1. Nizar, Muhammad Afdi, 2010. "Penentuan Efek Dan Arah Kebijakan Fiskal Pemerintah Indonesia: Fiscal Impulse Measure
      [Fiscal Policy Stance in Indonesia : Fiscal Impluse Measure]
      ," MPRA Paper 65603, University Library of Munich, Germany.
    2. Chakraborty, Lekha, 2015. "Fiscal Seigniorage "Laffer-curve effect" on Central Bank Autonomy in India," Working Papers 15/156, National Institute of Public Finance and Policy.
    3. Chakraborty, Lekha S, 2014. "Monetary Seigniorage in an Emerging Economy: Is there a scope for "free lunch" in financing public investment?," MPRA Paper 67497, University Library of Munich, Germany, revised 2015.
    4. Lekha S. Chakraborty, 2015. "Fiscal Seigniorage “Laffer-curve effect†on Central Bank Autonomy in India," Working Papers id:7754, eSocialSciences.
    5. Chakraborty, Lekha S, 2014. "Macroeconomics of “NaMo” Budget 2014 in India," MPRA Paper 67045, University Library of Munich, Germany, revised 2014.

    More about this item

    Keywords

    Fiscal stance; Output gap; Contracyclical fiscal policy; Stationarity; Cointegration; Asymmetric vector autoregression;

    JEL classification:

    • 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
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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