Deficit financing and consumption: a study of Indian private consumption expenditure

Abstract

The study reinvestigates the 'Ricardian Equivalence hypothesis in India by taking private consumption as the dependent variable. The study aims to empirically study the impact of debt financing versus tax of fiscal deficit in the Indian context, as Indian policymakers primarily rely on fiscal policy as a tool for economic stability and growth. ARDL, FMOLS and DOLS approach was used by taking annual time series data from 1988 to 2023. The study reinvestigates the 'Ricardian Equivalence hypothesis in India by taking private consumption as the dependent variable. Government expenditure, public debt, tax, domestic income, and liquidity constrain as independent variables. The estimates confirm a significant symmetric as well as symmetric long-run and short-run relationship between the variables; the results reject the Ricardian Equivalence and propound the Keynesian approach that financing the fiscal deficit (debt vs tax) does matter to the private consumption expenditure. The positive and significant coefficient shows that the increase in liquidity will lead increase in private consumption expenditure. Over-reliance on debt financing strategies has a significant influence on domestic private consumption. The liquidity constraints, fiscal policies will be able to reallocate resources from the future to the present. Since debt financing of deficits and liquidity substantially influence India's consumer spending, expansionary fiscal policies should be carefully devised and supported. This study contributes to the existing literature on deficit financing and 'Ricardian Equivalence' by giving new evidence on designing sustainable fiscal policy by spending wisely without imperilling the country's consumption expenditure.