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

Equations are estimated after testing for stationarity and structural breaks with
or without trend taking into account the current debate concerning trend-stationarity
versus difference-stationarity. The model is validated for the sample period. In general,
the sample period will covers the period from 1951-52 to 2006-07, subject to data
constraints.
This model is developed in a manner such that it is suitable for forecasting as
well policy simulations. It also provides an analytical framework for studying issues of
sustainability of government debt and deficit. The model is also suitable for application of
norms or prescriptive parameter changes in determining centre‟s and states‟ (taken
collectively) tax revenues according to major categories of expenditures of the centre and
states on the revenue account. It also provides estimates for the gross budgetary support
for the plan under alternative assumptions.
The outline of chapters is briefly described below. In this Chapter, apart from
these introductory observations on the usefulness of a macro-model for the Finance
Commission, an overview of salient trends in important macro variables is also
undertaken.
Chapter 2 provides a discussion on the nature of structural breaks in the Indian
economy and examines in this light the stationarity of these macro variables. It is
concluded that all variables of relevance are trend-stationary with structural breaks. In
each case the relevant break dates are identified.
Chapter 3 provides a discussion of the general specification of the model
including stochastic equations and identities. There is detailed fiscal sector within the
core model. In addition, there is fiscal sub-model to cater to further dis-aggregation,
where feedbacks with the core model are not significant. The revenue has equations for
major central and state taxes, non-tax revenues, and fiscal transfers and other
intergovernmental flows so that revenues and expenditures on the combined account of
the central and the state governments can be derived. Expenditures are divided into
revenue and capital expenditures. Revenue expenditures are further divided into interest
payments and primary expenditures. Similarly, equations for fiscal deficit at the centre
and the state levels and their accumulation into debt are developed.
The real sector is divided into agriculture, industry, and services sectors on the
supply side. On the demand side, components of private expenditures (consumption and
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