The Indian fiscal-monetary framework: Dominance or coordination?

Ashima Goyal

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: The worldwide move to constrain monetary and fiscal policy using rules is creating a switch from fiscal towards monetary dominance. India also implemented flexible inflation targeting and fiscal responsibility legislation. The theoretical arguments, openness to capital flows, and historical experience with the adverse effects of fiscal dominance that led to these changes are discussed. When output is demand determined, with a relatively greater impact of monetary policy on demand, while fiscal policy affects supply-side costs and therefore inflation, as in India, monetary dominance also has adverse effects. Since each policy acts more effectively on the other's objective, co-ordination is essential to achieve optimal outcomes. Under adverse movements in revenues and high interest rates public investment is the first to be cut. Growth can fall below potential while supply-side inflation persists. The paper examines one way of achieving better outcomes. Rules alone could be interpreted too strictly. Delegation to a more conservative fiscal and less conservative monetary authority, by removing the fears of non-cooperation, makes coordination with higher payoffs for both self-enforcing. Such constrained discretion gives the required long-term perspective, yet retains flexibility.

Keywords: Monetary and fiscal rules; Monetary versus fiscal dominance; delegation; Coordination (search for similar items in EconPapers)
JEL-codes: C72 E63 E65 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2018-03
New Economics Papers: this item is included in nep-cba, nep-knm, nep-mac and nep-mon
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Citations: View citations in EconPapers (6)

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