A dissection of Indian growth using a DSGE filter

Area of Science:

• Economics
• Macroeconomics
• Econometrics

Background:

• Sustainable recovery post-COVID-19 necessitates understanding past growth dynamics.
• India's GDP decomposition into potential output and output gap is crucial for policy.
• Previous analyses may not fully capture persistent growth rate shocks.

Purpose of the Study:

• To decompose Indian GDP into potential output and output gap using a DSGE model.
• To analyze the trajectory and drivers of potential output and output gap.
• To assess the inflation forecasting ability of the model's output gap estimates.

Main Methods:

• Dynamic Stochastic General Equilibrium (DSGE) model incorporating persistent growth rate shocks.
• Decomposition of Indian Gross Domestic Product (GDP) into potential output and output gap.
• Comparative analysis of output gap estimates against the Hodrick-Prescott (HP) filter for inflation forecasting.

Main Results:

• Potential growth in India decelerated to approximately 6% by 2020Q1 due to reduced technology growth.
• The output gap declined persistently since 2018Q1, driven by weak demand and increased investment adjustment costs.
• DSGE model output gap estimates show competitive inflation forecasting performance compared to HP filtered estimates.

Conclusions:

• Technological slowdown and demand-side factors significantly impacted India's potential growth and output gap.
• Financial and investment sector stress contributed to the widening output gap.
• The proposed DSGE model offers a valuable tool for macroeconomic analysis and inflation forecasting in India.