Abstract
The chronic government deficit (fiscal deficit) and increase in the price level (inflation) have become major concerns for economists and policymakers. While numerous studies have examined the twin problems of the fiscal deficit and inflation for both developed and developing economies, their results are inconclusive due to different estimation techniques, chosen time periods, selection of variables, etc. Therefore, we examined the fiscal deficit-inflation nexus in India for the period from 1980–81 to 2016–17 by employing the Autoregressive Distributed Lag (ARDL) and Nonlinear Autoregressive Distributed Lag (NARDL) approaches. The results of the ARDL approach found no evidence of linear relationship between fiscal deficit and inflation in the Indian context. Further, the empirical findings of the NARDL model confirmed the nonlinear relationship between fiscal deficit and inflation in the long run and no association between money supply and inflation, supporting the ideas of the Fiscal Theory of the Price Level (FTPL) in the case of India. FTPL postulates that public debt and taxation policies drive price level; monetary policy has an indirect role only. Therefore, fiscal policymakers should focus on reducing fiscal deficits. Simultaneously, the Reserve Bank of India (RBI) should regulate lending interest rate so that a mix of fiscal and monetary policies can be applied for controlling inflation in India.
Highlights
Harmonisation of fiscal and monetary policies is required to achieve macroeconomic stability in an economy
Fiscal deficits can only lead to inflation if they are monetized. [3] argued that central bank would be required to finance the deficit via monetization either or in the near future, resulting in an increase in money supply and the inflation rate in the long run. [4] noted that the rapid growth of money supply without fiscal deficit is rare, implying that the inflation rate is always a fiscal phenomenon
The present study examines the fiscal deficit–inflation nexus in India during 1980–81 to 2016–17 using both Autoregressive Distributed Lag (ARDL) approach to Cointegration
Summary
Harmonisation of fiscal and monetary policies is required to achieve macroeconomic stability in an economy. Since the early 1990s, the Indian economy has undergone several changes in the fiscal-monetary policy These include elimination of automatic monetization of the fiscal deficit via the creation of ad hoc treasury bills in 1997 and prohibiting the Reserve Bank of India (RBI) from purchasing government securities in the primary market under the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 [6]. The present study examines the fiscal deficit–inflation nexus in India during 1980–81 to 2016–17 using both Autoregressive Distributed Lag (ARDL) approach to Cointegration [42] and Nonlinear Autoregressive Distributed Lag (NARDL) Bounds Testing of Cointegration [43] Other macroeconomic variables such as oil prices, money supply and interest rate are considered for the analysis.
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