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

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Fiscal Deficits and Real Interest Rates

Deena Khatkhate and Dan Villanueva’s (henceforth KV) rejoinder (EPW, May 12) to my piece ‘On Fiscal Deficits and Real Interest Rates’ (EPW, April 14) is rather intriguing: after castigating me for my position they reach a conclusion which is in conformity with it. I had argued in my paper that the fiscal deficit has no direct bearing (i e, other than through a general equilibrium system, of which IS-LM is the simplest possible example) on the level of the interest rate, and that therefore the proposition that the fiscal deficit must be cut in order to lower the interest rate, lacks theoretical justification. They conclude: “The factual evidence also shows that interest rates can remain higher with a fiscal surplus, depending on other economic variables, than in a situation with a fiscal deficit”. Their conclusion appears to be in conformity with my argument, though not necessarily identical with it (since I was arguing on a ceteris paribus basis, i e, ruling out other simultaneous parametric changes). From their conclusion too the question should follow: what theoretical justification is there for the current official position that the fiscal deficit must be cut for lowering the real interest rate?

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