For close to twenty five years now the fiscal deficit has had a central place in the economic policy of the central government in India. In particular, as Lekha Chakraborty in her book titled, Fiscal Consolidation, Budget Deficits and the Macro Economy puts it “fiscal consolidation has become the norm”. Consolidation here invariably means the reduction of the deficit to some numeric target. Though the academic branch of the economics profession has been debating the consequences of deficits for close to four decades by now the policy discourse has not been particularly constrained by the evidence. It appears to have simply been assumed that fiscal consolidation is always and everywhere a desirable. Lekha Chakraborty takes us back to these useful academic debates of a few decades ago, with the explicit intention of testing the main propositions that have been advanced with regards to the economic consequences of deficits. In her words the intention of writing this book is “to fill this gap through applied macroeconometrics”. It may be said at the outset that she has done a fairly thorough job of it.
Among the findings of this study are that there is no evidence of the displacement of the private sector by public spending or of the existence of classical ‘crowding out’ whereby public deficits crowd out private investment ‘dollar for dollar’. Neither is there evidence of ‘financial’ crowding out. As for the impact of the deficit on the interest rate, it is found that the interest rate is influenced by inflationary expectations but not the deficit itself. Finally, while arguing that the macroeconomic impact of the fiscal deficit depends upon how it is financed Lekha Chakraborty concludes from her investigations that seigniorage financing “per se” is not inflationary. These are the core results of the study, and they may be considered significant enough to merit attention. On the basis of these findings the author speculates that “Given that fiscal deficit per se has less adverse macroeconomics consequences, has the move from “discretion’ to ‘rules’ – both fiscal rules and inflation targeting rules - been a transformation of macroeconomic policies to a New Macroeconomic Consensus in India? Would the disappearing deficits through fiscal rules have adverse long-run consequences on economic growth?” Two comments may be made here. First the author is right to flag that there appears to have been an uncritical acceptance of the main propositions of the new Classical macroeconomics in policy circles in India. In particular, inflation targeting has come to roost in India at time when it has lost its charm in the circle of Anglo-American economics. But the suggestion that the nature, as in the composition, of fiscal deficits in India may have had no impact on growth is not something that emerges from this study as it does not address the issue of the impact of persistent deficits on growth in India. And, finally, while there may well be an ‘obsession’ with numeric fiscal targets – which was Krugman’s characterisation of contemporary macroeconomic policy in India reportedly made at the 4th SBI Banking & Economics Conclave in Mumbai in July of this year - surely it would be wrong to speak of “disappearing deficits” as the fiscal consolidation in progress in India does not intend the elimination of deficits but confining them.
Arguably, three issues with regards to the practice of fiscal policy in India are of interest. First, what is the basis of the figure 3 percent that has been adopted as the target for the deficit? It has been rationalised as being based on the availability of household financial savings. But public finance economists in India have shown that household financial saving is actually increasing. Secondly, the direct contribution of the deficit to accumulating debt cannot be ignored. Even if the deficit has no adverse macroeconomic consequences we would want to reckon with the fact that we could be passing on debt to future generations without compensating them with a higher capital stock. Finally, there is the issue of hysteresis, whereby today’s output can affect the economy’s potential output. Delong and Summers (“Fiscal Policy in a Depressed Economy”, ‘Brookings Papers on Economic Activity’, Spring 2012 issue) have shown that in the presence of the ‘shadow of hysteresis’ it would be appropriate to raise the current fiscal deficit or suffer an increase in the long-run debt-GDP ratio. Though conceived of as a possibility in a depressed economy it is not without relevance in India today when the economy is found to be slowing. One would hope that now that she has cleared so much of the ground for us Lekha Chakraborty study would now turn her considerable research skills to investigating these important questions.
Pulapre Balakrishnan is Professor of Economics, Ashoka University, Sonepat and Senior Fellow, IIM, Kozhikode
The views expressed in the post are those of the author only. No responsibility for them should be attributed to NIPFP.