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

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Monetary Fiscal Coordination and the Evolution of Public Debt

A Simple Simulation Exercise

Using an accounting framework, this article simulates the evolution of the debt ratio based on four policy interventions. It recommends pursuing an expansionary monetary policy combined with an equally active and complementary fi scal policy. The article also says that monetary policy should target the debt ratio, while fi scal policy should target output.

The author would like to thank the anonymous referee(s) Arjun Jayadev and Krithika Raghavan for their comments on a previous version of this article. All errors remain his own.

The COVID-19 pandemic has exacerbated the downturn in an already stagnating economy, with production still below pre-pandemic levels. After a record shrinkage of 23.9% in the June quarter, the growth rates still remain in negative territory, with positive growth rates expected only in March 2021 (Mishra 2020). Commentators fear that the financial resources required to combat a crisis of such magnitude will lead to a sharp rise in the debt-to-gross domestic product (GDP) ratio, with former Chief Economic Advisor Arvind Subramanian predicting it to rise to 85% of the GDP from the current 70.4% (Press Trust of India 2020).

The pandemic has created many possibilities for the evolution of India’s debt trajectory over the next few years. In this article, I present four scenarios of debt evolution and assess the impact of the associated policies leading to these trajectories. Using simulations, I show that the best-case situation for the debt trajectory is when the government cuts interest rates, while attempting to reduce debt by cutting spending is only the third best. Consequently, to successfully manage the debt ratio, the government needs to keep interest rates low and increase spending.

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Updated On : 31st May, 2022
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