Impact of Fiscal Policy Shocks on the Indian Economy

Abstract

In this article, we analyse the impact of fiscal shocks on the Indian economy using structural vector auto-regression (SVAR) methodology. The study uses quarterly data for the period 1997Q1–2009Q2. Two different identification schemes have been used to assess the effects of shocks on government spending and tax revenues on output. The recursive scheme is based on the Cholesky decomposition and the second identification scheme of Blanchard & Perrotti’s (1999) technique of using information on the tax system to identify the SVAR model. We find that the impulse responses obtained from both identification schemes behave in a similar fashion but the values of the multipliers differ. Also, the shock-to-tax variable has a bigger impact on gross domestic product (GDP) than the government spending shock. In the extended four variable VAR model, the effects of fiscal shocks on private consumption has been assessed using the recursive identification scheme. Findings indicate that the tax variable has a larger impact on private consumption compared to the government spending variable. In the short run, the impact of expansionary fiscal shocks follows the Keynesian tradition but the long-run response is mixed. JEL Classification: C32, E32, E62