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Monetary versus fiscal policy in India: an SVAR analysis

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  • Sanchit Arora

Abstract

Conventionally, the policymakers relied on three policy alternatives to manage business cycles – debt-financed government spending, debt-financed tax rebate and interest rate. While the first two are fiscal policy instruments, the latter is a monetary policy instrument. This paper aims to capture interactions among Indian monetary and fiscal policy actions, and the impact of such policy actions on select macroeconomic variables for the period 1990Q1–2011Q4. The policy actions are identified using the sign restrictions approach combined with magnitude restrictions in a Structural Vector Autoregression framework, and interpreted using impulse responses and variance decomposition. The results show that Indian monetary policy responds to tax rebate shocks and spending shocks differently. In the case of a tax rebate shock, Indian monetary policy responds by reducing interest rates thereby accommodating fiscal expansion. On the opposite, monetary policy seems not to accommodate expenditure shocks. Interestingly, the monetary policy shock is accompanied by a fiscal expansion that threatens the credibility of the central bank actions, thus indicating fiscal policy dominance. A comparison of the efficacy of the policies suggests that the interest rate is more effective in stimulating output. Out of the two fiscal policy instruments analysed, the tax rebate seems to be the better option for stimulating output considering the output-debt trade-off.

Suggested Citation

  • Sanchit Arora, 2018. "Monetary versus fiscal policy in India: an SVAR analysis," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 11(3), pages 250-274, September.
  • Handle: RePEc:taf:macfem:v:11:y:2018:i:3:p:250-274
    DOI: 10.1080/17520843.2017.1297325
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    Cited by:

    1. Abdhut Deheri, 2021. "The Effects of Monetary Policy on Output and Inflation in India: A Time-varying Approach," Economics Bulletin, AccessEcon, vol. 41(3), pages 1603-1614.
    2. Nitin Arora & Shubham Monga & Dilpreet Sharma, 2022. "Coordination of Monetary and Fiscal Policies for Growth with Price Stability in a Post‐COVID‐19 Indian Economy," Economic Papers, The Economic Society of Australia, vol. 41(3), pages 247-259, September.
    3. Narayan Sethi & Saileja Mohanty & Sanhita Sucharita & Nanthakumar Loganathan, 2020. "Tax Reform And Economic Growth Nexus In India: Evidence From The Cointegration And Rolling-Window Causality," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 65(06), pages 1699-1725, December.

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