Inflation and Fiscal Deficit in India: An ARDL Approach

Gurleen Kaur

Global Business Review, 2021, vol. 22, issue 6, 1553-1573

Abstract: Global financial crisis of 2008 which marked its 10th anniversary recently has intensified the problem of fiscal deficit and inflation which happen to be the two foremost macroeconomic challenges confronting the Indian economy. In the light of unsettled debate pertaining to the inflationary tendencies of fiscal deficit, the present study attempts to empirically examine the important macroeconomic determinants of inflation in India and investigates whether the proposition of a positive effect of fiscal deficits on inflation can be verified in the particular case of the Indian economy using quarterly data from Q1: 1996–1997 to Q1: 2016-2017. The ARDL Bounds approach to cointegration reveals the existence of long-run relationship between inflation; gross fiscal deficit; money supply; exchange rate; crude oil prices; and output gap. The long-run and short-run dynamics indicate that gross fiscal deficit and money supply generate negative impact on inflation in India. From the supply side, crude oil prices and exchange rate are found to be playing an important role in determining domestic prices. From the demand side, in the absence of a stronger output-inflation relationship, the support for flexible inflation targeting framework does get encumbered as the case for the existence of Phillips curve in India further weakens through our analysis. This result bears significance especially in the context of a switch to a rule based anti-inflationary strategy in India.

Keywords: ARDL approach; exchange rate; fiscal deficit; inflation; India; money supply; output gap (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:sae:globus:v:22:y:2021:i:6:p:1553-1573

DOI: 10.1177/0972150919828169

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