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Fiscal dominance in India: an empirical estimation
1Economic Division, Department of Economic Affairs, Ministry of Finance, New Delhi, India.
Indian Economic Review
|June 14, 2022
Summary
Fiscal dominance, where fiscal policy influences monetary policy, showed varied impacts in India. Before 2003, improved fiscal balance boosted interest rates and growth; after 2003, this dominance faded.
Area of Science:
- Economics
- Monetary Policy
- Fiscal Policy
Background:
- Theoretical literature suggests fiscal dominance can harm economies.
- Recent studies indicate potential benefits under specific conditions.
- The relationship between fiscal and monetary policy requires nuanced understanding.
Purpose of the Study:
- To analyze fiscal dominance in India.
- To measure the impact of fiscal balance on interest rates and GDP growth.
- To determine the persistence of fiscal dominance in the Indian economy.
Main Methods:
- Vector Error Correction Model (VECM) framework.
- Analysis of Centre's primary fiscal balance.
- Examination of real interest rates and real GDP growth rates.
Main Results:
- Prior to 2003, improved fiscal balance positively impacted real interest rates.
- From 1978-2003, fiscal dominance was evident, with fiscal improvements positively affecting growth.
- After 2003, evidence of fiscal dominance in India diminished.
Conclusions:
- Fiscal dominance in India has evolved over time.
- The impact of fiscal policy on monetary conditions and economic growth is context-dependent.
- Complete separation of fiscal and monetary policy may not always be optimal.
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