The IUP Journal of Applied Economics
Does Government Deficit Crowd Out Private Investment? An Empirical Analysis for National and Sub-National Governments

Article Details
Pub. Date : Jul, 2019
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE11907
Author Name : Pushpa Trivedi, Sangita Misra, Kaushiki Singh and Lavanya Ammu
Availability : YES
Subject/Domain : Economics
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No. of Pages : 30

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Abstract

Expansionary fiscal policy can stimulate or retard growth in an economy depending on whether it crowds in or crowds out private investment. Amidst mixed results in the literature, the present study makes a comprehensive attempt to examine crowding out evidence by exploring the link between Gross Fiscal Deficit (GFD) on the one hand, and real interest rates and private investment, on the other, in a time series framework for the central government and panel framework for 23 state governments. The Autoregressive Distributed Lag (ARDL) cointegration results confirm the existence of a long-run equilibrium relationship between GFD, adjusted for cycles, and real rate of interest for central government for the period 1980-81 to 2017- 18, thus supporting financial crowding out. While support for real crowding out is weak for central government, for the state governments, support has been found for real crowding out, with the strength of the coefficient rising when GFD is financed by gross market borrowings. This reinforces the need for both tiers of government—national and sub-national—to continue efforts towards fiscal consolidation, improving the quality of expenditure and to try financing their deficits less via market borrowings and more through own revenues.


Description

The debt-deficit dynamics of the fisc and its interplay with monetary management are important in deciding the macroeconomic consequences of fiscal slippages on real rate of interest and private investment. In recent years, in the context of macroeconomic management in India, there has been greater emphasis on fiscal deficit reduction as high fiscal deficit affects capital formation in the economy via two channels—increasing interest rates resulting in reduction in private investment and also reducing government sector’s own investment due to higher revenue or consumption expenditures, usually called the ‘crowding out’. Crowding out, thus, refers to the reduction in private investment that results when the fisc adopts an expansionary policy.

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