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Fiscal Deficit, Capital Formation, and Crowding Out in India: Evidence from an Asymmetric VAR Model

Lekha cHAKRABORTY

Economics Working Paper Archive from Levy Economics Institute

Abstract: This paper analyzes the real (direct) and financial crowding out in India between 1970–71 and 2002–03. Using an asymmetric vector autoregressive (VAR) model, the paper finds no real crowding out between public and private investment; rather, complementarity is observed between the two. The dynamics of financial crowding out is captured through the dual transmission mechanism via the real rate of interest—that is, whether private capital formation is interest-rate sensitive and, in turn, whether the rise in the real rate of interest is induced by a fiscal deficit. The study found empirical evidence for the former but not the latter, supporting the conclusion that there is no financial crowding out in India. The differential impacts of public infrastructure and noninfrastruture innovations on the private corporate sector are carried out separately to analyze the nonhomogeneity aspects of public investment. The results of the Impulse Response Function reinforced that no other macrovariables, including cost and quantity of credit and the output gap, have been as significant as public investment—in particular, public infrastructure investment—in determining private corporate investment in the medium and long terms, which has crucial policy implications.

Date: 2007-10
New Economics Papers: this item is included in nep-cwa and nep-mac
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