Estimating India’s fiscal multiplier..

The blogger attended a stirring talk by Dr NR Bhanumurthy of NIPFP at IIM, Bangalore yesterday based on this paper.

In the paper he and his colleague calculate fiscal multipliers based on a model spanning for 20 years. There is hardly any research on the fiscal multiplier issue in India and this paper tries to bridge the gap.The paper shows India has a much larger multiplier in case govt expenditure is for capital creation than for wasteful revenue exp (which is fairly intuitive). However, in case of tax multiplier, we get a negative multiplier:

Annual data for the period 1991-2012 has been used for estimation of the model. In this exercise, we estimate fiscal multipliers under two scenarios: when there is no restriction on the
fiscal deficit and when there is a restriction on fiscal deficit as suggested by the Thirteenth  Finance Commission. To obtain the fiscal multipliers, a shock is given to the appropriate fiscal
policy variable in the year 2012-13 and its impact traced on output from the baseline. Table 1 presents the impact multipliers for expenditure changes, i.e., for one unit change in expenditure
what is the change in output by the end of the year of the shock .

The estimated value for expenditure multipliers ranges from 0.98 to 2.45, depending on the type of expenditure. Compared to the revenue expenditure multipliers, the capital expenditure
multiplier is higher. A value of 2.45 for capital expenditure multiplier implies that an increase in capital expenditure of the government by Rs.1 crore would raise the GDP by Rs 2.45 crores by
the end of the year, where both are measured in nominal terms.

The exact transmission mechanism is as follows. (a) An increase in government’s capital expenditure stimulates public investment in a significant way. This in turn crowds-in private
investment, and both contribute to higher spending. (b) The complementarity of public and private investment is empirically observed to be fairly strong and so is the accelerator effect of
output on investment. (c) Interest rates are seen to go up marginally as fiscal deficit rises due to higher public expenditure, but the crowding out effect of the interest rates on private
investments is overshadowed by the accelerator effect acting on private investment. (d) The high import propensities (gold, oil and rest of the imports) results in substantial leakage from demand and causes trade deficit to widen.14 The final multiplier values subsume, inter alia, these effects. 

The revenue expenditure multipliers work through the consumption channels; whereas an increase in transfer payments raises private consumption expenditure by raising the disposable
income of individuals, other revenue expenditure augments public consumption expenditure directly. The multiplier effects of these expenditures is close to one and the crowding out of
private expenditure, as is popularly observed, is not seen either in the year of the shock or in the subsequent years. 

Though tax multipliers came as -ve which was a shocker. I mean we usually hear/read papers where we debate whether the multiplier is between 0 and 1 or more than one. But negative??

To estimate tax (revenue) multipliers, a shock was given to a particular tax rate and its impact on output simulated. Tax multiplier for a particular tax category is the ratio of change in nominal output to change in that particular tax revenue. These have been estimated for the major indirect tax, goods and services tax (GST), and the two important sources of direct tax revenues, corporate tax and income tax. Estimates of tax multipliers so obtained are close to minus one.

The tax multiplier works in the following way. A positive shock to the GST rate, causes GST revenues to rise. There is substantial fall in private consumption, due to lower disposable
incomes. Private investment also falls as the overall level of economic activity declines. Rise in tax revenue lowers the revenue deficit and fiscal deficit, while public investment and public
consumption remains unchanged as per the assumptions of the model. Both fiscal balance and current account balance improve. Significantly, the gains in tax revenues are lower than the
change in GST revenue since the other heads of tax revenues decline.

They have a box showing we can have negative multipliers in case of some special situation. In India’s case we do have a special situation..

The broad idea is fiscal deficit redline of 4.8% of GDP alone does not matter. What matters is the quality of fiscal consolidation:

The present macroeconomic landscape in India demands a policy thrust that would combine high growth in output while also bringing back fiscal discipline in the economy. Many
commentators have regarded the fiscal situation in the recent years as precarious and warned about several adverse consequences stemming from it. However, to understand the
consequences of the type of government expenditures, there is a need to have an idea on the size of fiscal multipliers, which for India unfortunately is not available at the moment in the literature. The present study fills this gap and provides a framework as well as preliminary estimates of various fiscal multipliers. The estimated size of multipliers suggest that the thrust of government expenditure expansion has to shift in favour of capital expenditure.

As always is the case, did not understand the model at all. Need to read this paper carefully to figure what is going on…

One Response to “Estimating India’s fiscal multiplier..”

  1. Gunajit Kalita Says:

    RBI working paper series has recently published a paper on fiscal multiplier, on first glance it seems these estimates are much higher than what RBI paper has calculated. They had used SVAR to make the estimate, but it would be good to compare their result. Nevertheless, it is good to have research on this.

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