Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/79475
Authors: 
Chakraborty, Lekha S.
Year of Publication: 
2012
Series/Report no.: 
Working Paper, Levy Economics Institute 744
Abstract: 
Controlling for capital flows using the high-frequency macro data of a financially deregulated regime, this paper examines whether there is any evidence of the fiscal deficit determining the interest rate in the context of India. The period of analysis is FY 2006-07 (April) to FY 2011 (April). Contrary to the debates in policy circles, the paper finds that an increase in the fiscal deficit does not cause a rise in interest rates. Using the asymmetric vector autoregressive model, the paper establishes that the interest rate is affected by changes in the reserve currency, expected inflation, and volatility in capital flows, but not by the fiscal deficit. This result has significant policy implications for interest rate determination in India, especially since the central bank has cited the high fiscal deficit as the prime reason for leaving the rates unchanged in all of its recent policy announcements. The paper analyzes both long- and short-term interest rates to determine the occurrence of financial crowding out, and finds that the fiscal deficit does not appear to be causing either shorts and longs. However, a reverse causality is detected, from interest rates to deficits.
Subjects: 
fiscal deficit
asymmetric vector autoregressive model
financial crowding out
JEL: 
C32
E62
H6
Document Type: 
Working Paper

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