Robert Zoellick made a perceptive point at a recent World Bank seminar on “Markets and Crises: What Next and How?”
The World Bank president compared the fiscal policies that the US and China have announced to fight their economic problems. “The US is favouring consumption, while China is favouring investment. In the long run, these two countries will have to trade places, with the US switching to greater levels of investment and China switching to greater consumption,” writes Ryan Hahn at the World Bank’s Crisis Talk blog.
There are two implicit points here. One, there could be a growing tension between the short-term need to support economic activity at any cost and the long-term need to rebalance both the American and Chinese economies, with the former spending less and the latter saving less. Two, macroeconomic stabilization policies should ideally have a strategic vision embedded in them.
That is what I find particularly distressing about the Indian policy debate. This column has been arguing for at least a year that the Manmohan Singh government’s callous attitude towards fiscal discipline will harm the economy in times of trouble. But that is now a done thing and I realize it is impractical to expect the government to try to reduce its deficit when the economy is in the midst of a painful slowdown. So, let’s close that debate for now.
If higher fiscal deficits are unavoidable—at least till the next macroeconomic crisis hits us—then the least we can expect is for the government and top policymakers to explain why they are doing what they are doing. There is frankly no clarity at all in the Indian government’s fiscal strategy.
The standard assumption is that a higher fiscal deficit will put more money in the hands of consumers and businesses. They will spend part of this money that will then go to other families and businesses which, in turn, will spend part of it and so on. So, an increase of one unit in the government deficit will raise output by more than one. By how much it will indeed be raised is calculated using the Keynesian multiplier, which is dependent on how much every extra rupee coming to people is spent and how much is saved.
The multiplier can change depending on what has led to an increase in the fiscal deficit—lower direct taxes on families and companies, lower indirect taxes on consumption, higher capital spending, higher revenue spending, higher subsidies and so on.
The Manmohan Singh government has pushed the fiscal deficit 3.5 percentage points above its budgeted target for the current fiscal year. Most of this has come from higher revenue spending and subsidies. We have to add to that the 1.8 percentage points of bonds issued outside the budget to fund oil and fertilizer subsidies.
The very least this profligate government can do is to explain to citizens why it chose to spend an extra 5.3% of national output on higher staff salaries, subsidies, farm loan write-offs and the rest. Would it have been better for economic growth if all this money had been accounted for by a huge tax cut or higher capital investment? What are the assumptions about the respective multipliers?
I have seen no official document that tries to provide an explanation. And nor have independent academic economists offered any research on what the Keynesian multipliers applicable to India right now are. To that extent, the entire debate on how fiscal policy should be used to support economic activity is hollow.
There is a similar lack of clarity as far as monetary policy goes. The Reserve Bank of India (RBI) has been busy trying to ease monetary policy in India. But the two main channels that transmit central bank policy into the real economy—the interest rate channel and the credit channel—seem to be clogged. In other words, banks have not cut lending rates with the same alacrity with which the central bank has cut policy rates—and they have preferred to park money in government bonds rather than lend to companies.
Once again, I have seen little serious academic research on how the transmission mechanism for monetary policy in India is working, and whether RBI would be better advised to try to slash policy rates or ease credit flow or try something usual such as print money (as many economists are now advising it to do).
The current slowdown in the Indian economy promises to be a long and painful episode, and the next government will have to take big risks to support economic activity even as it battles a scary fiscal deficit. What India will need is a reasoned and empirical debate on what fiscal and monetary policy choices need to be followed. Else all we will have is guesswork and shouting matches.
It is high time academic economists with no axes to grind stepped in and filled the analytical void.
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