The case for stimulus is stronger when fiscal deficits are small to begin with
Economists at the Reserve Bank of India (RBI) have estimated that a 100 basis point increase in the fiscal deficit, expressed as a proportion of gross domestic product (GDP), could lead to a permanent increase of 50 basis points in inflation. This is when the fiscal deficit is 5.9% of GDP to begin with. An equally important finding is that the inflation impact of higher fiscal deficits in India depends on initial conditions. The inflation impact is higher when the initial fiscal deficit is higher.
There are two important takeaways from this analysis. First, it grounds the current debate on fiscal stimulus in hard empirical estimates rather than the airy claims that have been made in public debates. Commentators will now have to give their own statistical analysis if they disagree with the estimates of the Indian central bank. Second, the analysis should be read as a reiteration of the truth that the case for stimulus is stronger when fiscal deficits are small to begin with. Too many people seem to glide over this inconvenient fact.
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