ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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On Fiscal Deficits and Real Interest Rates

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Prabhat Patnaik is once again in harness with his strictures, by now familiar to readers of EPW, on the proposition that "the size of the fiscal deficit affects the level of interest rates", which he attributes to the pernicious influence of the thinking of the Bretton Woods institutions on Indian economists, including many who would not consider themselves to be votaries of 'liberalisation' ('On Fiscal Deficits and Real Interest Rates', EPW, April 14, 2001). This time the provocation for him to repeat his strongly held beliefs is the report of the Prime Minister's Economic Advisory Council (PMEAC), which makes him more strident in his analysis with liberal use of epithets like 'absurd', 'obnoxious', etc, and the rebuke that the group of distinguished economists that constitutes the PMEAC has put forward an argument which assumes Keynesian full employment. Patnaik has attempted to pose his argument with subtlety, an aura of analytical sophistication and a persuasive skill which makes it prima facie convincing. There is, therefore, a warrant to subject Patnaik's proposition to a little more scrutiny before it becomes a new 'mantra' for the critics of the reform policies in India 

Before we embark on this, it is necessary to bear in mind the epistemological nature of economics as a science. One can start with any assumption of one's choice and proceed to derive results which conform to the preconceived notions. Patnaik makes it clear that he is analysing the linkages between fiscal deficits and real interest rates in a closed economy model; exchange rates and the balance of payments figure nowhere in his analytical framework. It is obvious that if his assumptions are replaced by other sets of assumptions closer to reality, the conclusions are apt to be considerably different from those he espouses. In our comment we will remain focused on the reality of the Indian economy to the extent possible insofar as the assumptions are concerned and see, by using Patnaik's analytic construct, if the results which we obtain approximate his to any substantial degree

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