New issues in Indian macro policy.



4 Conclusion

The basic relationships in Indian macroeconomics have changed profoundly in recent years.
The main point of this article is to highlight the fundamental structural change that has
taken place at a qualitative level. These changes have the following implications:

• Caution when working with data When aiming to obtain insights into the present
structure of the economy, the enterprise of empirical macroeconomics needs to be
careful in specifying models which make logical sense under present conditions, and
estimation efforts need to carefully test for structural breaks.

Indeed, given the short data series in the ‘new regime’, estimation of relationships
through formal econometrics may often be infeasible. In this case, there may still
be valuable insights obtained by thinking through the qualitative relationships that
prevail in this new world, based on the ideas of open economy macroeconomics.

• Skepticism about the traditional policy framework An intuitive understanding of the
dynamics and responses of Indian macroeconomics that is rooted in earlier experi-
ences must be treated with caution. The relationships have changed. The macro
policy framework which worked well in the 1980s and the 1990s can no longer be
applied in the present setting.

• A continued focus on fiscal stability This involves an elimination of off-balance sheet
deficits, prudent handling of the proposals of the sixth pay commission, achieving
strong fiscal outcomes in the present business cycle upturn so as to be able to achieve
the FRBM targets in a downturn, and prudence in expenditure programs.

• New thinking on fiscal policy In order to complete the half-finished fiscal consolida-
tion, and to re-orient fiscal policy so that it can play a role in stabilisation of the
business cycle, an FRBM-II Act needs to be enacted, with the following key features:

1. Good quality measurement and disclosure of deficits and debt;

2. Elimination of all off-budget financing;

3. A limit on the consolidated fiscal deficit of centre and states of roughly 3% of
GDP;

4. A mechanism for varying the fiscal deficit based on business cycle condition.
Roughly speaking, this may require that the government
budget for a consoli-
dated deficit of 1% of GDP, a target which is achieved under strong business
cycle conditions, but worsens to no more than 3% of GDP under recessionary
conditions.

• New thinking on monetary policy While India has made important progress on re-
forms to public finance, monetary policy has not been comparably reconstructed. An
Indian Monetary Authority Act needs to be enacted, with the following key features:

24



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