A Macro-Fiscal Modeling Framework for Forecasting and Policy ...

formulation of the recommendations of the Commission. In particular, the Commission
has been asked as part of ToR the following:
Para 5: “The Commission shall review the state of the finances of the Union and the
States, ….., and suggest measures for maintaining a stable and sustainable
environment consistent with equitable growth”.
Para 6 (ii): The demand on the resources of the Central Government, in particular on
account of the projected Gross Budgetary Support….debt servicing and other
committed liabilities”.
Para 6 (v): the impact of the proposed Goods and Services Tax….including its impact on
the country‟s foreign trade. (underlines added)
These issues can be effectively addressed using a macro-econometric modeling
framework prepared for forecasting and simulations after taking into account the relevant
interrelations among key real, fiscal, trade, and monetary aggregates and ensuring that
the relevant definitions and identities are satisfied. Macroeconomic model, because of its
capacity to capture complex and dynamic interrelationships among economic variables, is
a powerful analytical tool that can be useful for studying issues of fiscal transfers,
particularly as projections for five years are an integral part of the institutional
framework of determining transfers under the aegis of the Finance Commission. It is
useful for addressing issues of determining sustainable levels of public debt and fiscal
deficit, monetization of deficit, impact of globalization of the Indian economy, and the
economy‟s growth prospects in the medium term.
In contrast with other major federations where the exercises for determining
vertical and horizontal transfers are undertaken contemporaneously or effectively
contemporaneously, the Finance Commissions in India must forecast because the
recommendations period extends to five years and the Commission must use available
information, which under the best of circumstances may be seven to eight years prior to
the final year of the recommendation. Critical variables that must be forecasted are the
magnitude of central tax revenues and own tax revenues of the states, the committed
expenditures in the form of interest payments, levels of other revenue expenditures and
any desired policy interventions to uplift standards of selected services like health and
education.
Other major federations undertake fiscal transfer exercises in a manner that the
need for forecasting fiscal aggregates can be avoided. For example, in Australia the
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