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

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Acknowledgements We are thankful to the Thirteenth Finance Commission for entrusting this study to us. We have benefited considerably from discussions with the Hon‟ble Chairman of the Commission, Dr. Vijay Kelkar, Hon‟ble Members, Dr. Atul Sarma, Dr. Indira Rajaraman, Shri B.K.Chaturvedi, and Dr. Sanjiv Misra, and the Economic Advisor, Dr. Rathin Roy and other senior officials of the Commission. We had occasion to present and discuss the findings of the study to the Commission and the comments that we received benefitted us considerably in finalizing the report. Shri Sumit Bose has been very helpful at all stages of the work. At the MSE, we have benefited from our discussions with Dr. C. Rangarajan and late Dr. R.J. Chelliah. In the preparation of the manuscript we have been helped considerably by Ms Sudha and Ms Jothi at the Madras School of Economics. We are thankful to all of them for their help at various stages in the completion of this study. D.K. Srivastava K.R. Shanmugam C. Bhujanga Rao iii
Overview and Rationale EXECUTIVE SUMMARY 1. The Thirteenth Finance Commission is required to make its recommendations regarding sharing of central taxes with the states and grants covering the period 2010-11 to 2014-15. This necessitates projection of revenues and expenditures of both the central and the state governments for the period up to 2014-15 with a view to making assessments of centre‟s as well as states‟ fiscal capacities and respective needs. 2. The approach of the previous Finance Commissions has been to generally undertake these projections on the basis of historical trends of revenues and expenditures considered individually although certain prescriptive and normative parameters were applied for both the base year numbers and parameters used for the projections period to modify the trend-based projections. For macro variables like income and prices, certain growth rates were adopted for the respective award periods. Projections based on trends or tax- buoyancies do not take into account the interdependence of the fiscal variables with other key sectors of the economy including the real, monetary and trade sectors. In fact, government‟s expenditure and revenues need to be jointly determined after taking into account the relevant interdependence between real, monetary, external, and fiscal sectors including debt and fiscal deficit. 3. 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. A macroeconomic model because of its capacity to capture complex and dynamic interrelationships among economic variables is a suitable 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. iv
Page 1 and 2: MONOGRAPH 22/2012 A Macro-Fiscal Mo
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Page 7 and 8: centre‟s and states‟ (taken col
Page 9 and 10: to nearly fully replicate the growt
Page 11 and 12: sustained stimulus to the economy c
Page 13 and 14: CONTENTS Preface Acknowledgements E
Page 15 and 16: 5.4 Selected Tax Revenues: Summary
Page 18 and 19: Chapter 1 1.1 Background INTRODUCTI
Page 20 and 21: elativities or shares of provinces
Page 22 and 23: (VECM) as well as structural cointe
Page 24 and 25: (a) First Phase: Models up to Sixti
Page 26 and 27: short-term variations around long-t
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Page 30 and 31: (i) Output Growth The output growth
Page 32 and 33: Chart 1.3: Private Consumption and
Page 34 and 35: Chart 1.6: Interest Rates: Long-ter
Page 36 and 37: On the other hand, during 1950-51 t
Page 38 and 39: Chart 1.11: Revenue Deficits as % o
Page 40: 1.6 Summary In this Chapter we have
Page 43 and 44: (1987). Many economists thought tha
Page 45 and 46: equation, the trend and structural
Page 47 and 48: Papell (1997), and Morimune and Nak
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Page 51 and 52: 7. Hatekar-Dongre (2005) argue that
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used to select the optimal number o
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83, and 1997-98. KRS has three brea
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IDR has four break dates in the yea
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Structural Variables Names Break Da
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The real and external sectors are l
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Government investment expenditure i
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compensation of employees to the re
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36. Union Excise Duties: LUDR = f {
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CBKE = CBFDO+CBNDKR-CBRD 64. Combin
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(b) Exogenous Variables Exogenous v
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interest payments; it arises mainly
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the structural break dummy D81, all
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eak dummies (D64, D88 and D99) for
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Table 4.5: Industrial Output Depend
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Table 4.7: Investment in Agricultur
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4.5 External Sector Demand for Impo
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Table 4.12: Demand for Broad Money
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Table 4.14: Long Term Interest Rate
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Table 4.16: Implicit Price Deflator
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Table 4.18 Unit Value of Exports De
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Table 4.20: Income Tax Revenue Depe
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Table 4.22: Union Excise Duties Dep
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Table 4.24: Central Effective Inter
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Table 4.26: State Other Indirect Ta
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Table 4.28: Testing for First Order
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larger the error, the larger will b
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c. Limitations of Comparisons betwe
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The terms thus provide information
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5.3 Investment Variables Table 5.1
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all these variables accurately. The
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Chapter 6 FORECASTS: BASE AND REFOR
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a. Macro Indicators The average gro
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Year Income Tax (ITR) Table 6.4: Ce
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Year Revenue Expenditures (CRE) Tab
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Year Table 6.8: State Finances: Rev
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throughout the period 2010-11 to 20
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Year Table 6.12: Combined Finances:
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On the state finances, there will o
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Year Table 6.16: Combined Finances:
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Year Table 6.17: Forecasts of Macro
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Year Table 6.19: State Finances: De
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provided for in order to stimulate
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In order to identify whether the In
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with a balance of payment identity.
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model-forecasts are taken as condit
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Table 7.3: Forecasts of Major Fisca
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In Scenario 2, the following are th
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Commission. This is because of the
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Balakrishnan, P and K. Pushpagandan
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Dickey, D.A. and W.A. Fuller (1979)
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Krishnamurty, K. (1984), “Macroec
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Pandit, V. and B.B. Bhattacharya (1
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Yule, G.U. (1927), “On a Method o
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No. Name Description Unit Source (B
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No. Name Description Unit Source (B
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Exogenous Variables Appendix A3.2 L
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Appendix A4.1 TESTING FOR SERIAL CO
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11 Dependent Variable: RSLEXPR Samp
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21 Dependent Variable: RSLSSR Sampl
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1. Variables YR and YN Appendix A5.
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3. Variables RSN and RLN Years RSN
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5. Variables ITR and CPTR Years ITR
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7. Variables CRR and CRE Years CRR
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9. Variables SRR and SRE Years SRR
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11. Variable YSR Years YSR Forecast
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for 3 years is based on projection
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12. SS: Share of States in Centre
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Appendix A6.2 FORECAST FOR SELECTED
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Years IDR IG CBOBB CBFDO IIR IMPR 2
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Years SKE SOITR SRD SRE SRR SSR 200
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MSE Monographs * Monograph 9/2010 F
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