Nexus between inflation and fiscal deficit: a comparative study of India and China
| DOI | https://doi.org/10.1108/JCEFTS-07-2021-0028 |
| Published date | 24 March 2022 |
| Date | 24 March 2022 |
| Pages | 193-216 |
| Subject Matter | Economics,International economics |
| Author | Gurleen Kaur |
Nexus between inflation and fiscal
deficit: a comparative study of
India and China
Gurleen Kaur
Department of Economics, Sri Guru Gobind Singh College of Commerce,
University of Delhi, New Delhi, India
Abstract
Purpose –The purpose of this paper is to examine the deficit–inflation nexus in thetwo fastest growing
economies, India and China, which happen to be crucial affiliates of the global growth generator countries
apart fromtheir association in Brazil, Russia, India,China, and South Africa.
Design/methodology/approach –The paper uses the prism of the vector auto regression framework,
for the period 1985–1986 to 2016–2017for both India and China. For this purpose, gross fiscaldeficit, money
supply, exchangerate, crude oil prices and output gap are examined as the key elements in the determination
of inflation. The econometric framework used chiefly comprises of cointegration analysis, vector error
correctionmodel, Granger causality and impulse responsefunctions.
Findings –The findings of this paper support the hypothesisthat fiscal deficits are inflationary only in the
Indian context and that the Ricardianequivalence cannot be negated for China at least in the short run. The
results presented in the paper are a little agnostic about whether New Keynesian Phillips Curve (NKPC)
explains the inflation dynamics in India, given that both inflation inertia and output gap are not robust.
However, for the Chinese economy, NKPC alongwith structural theory is instrumental in describing trends
pertainingto inflation during the period of the study.
Practical Implications –The paper warrants broaderpolicy framework to aim at addressing structural
bottlenecksto ensure non-inflationary growth keeping in mindthe structural views on inflation. Furthermore,
the paper fosters greater synthesis between monetary and fiscal policies, especially considering the global
economicdisruptions the world economy is subject to.
Originality/value –Considering there are only a limitednumber of studies on fiscal deficit of China, the
present paper is of paramountsignificance in terms of growing concern over the sustainabilityof the growth
process in China. Additionally, the paper is first-of-its-kind attempt to account the effectivenessof a healthy
monetary–fiscalinterface in achieving macroeconomicstability in India and China.
Keywords Exchange rate, Fiscal deficit, Inflation, Money supply, New Keynesian Phillips curve,
Output gap, Ricardian equivalence
Paper type Research paper
1. Introduction
The episode of global financial crisis (GFC) and economic disruptions like Covid-19 flag the
issue of containing inflation and fiscal deficit as a prerequisite for reviving growth in
emerging marketeconomies (EMEs). Fiscalpolicy which is permanently expansionary is not
only highly unsustainable but also often blamed for high and persistent inflation. Much of
JEL classification –C32, E31, E51 and H62
The authors would like to thank anonymous referees and the Editor of the journal for their
constructive suggestions and comments. The usual disclaimer applies.
Funding: The authors did not receive any funding to complete this study.
Inflation and
fiscal deficit
193
Journalof Chinese Economic and
ForeignTrade Studies
Vol.15 No. 2, 2022
pp. 193-216
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-07-2021-0028
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1754-4408.htm
the prevailing literature is full of the unfriendly results of inflation irregularities but has
not explored its major sources and deficit–inflation nexus in the two fastest growing
economies, India and China, who happen to be crucial affiliates of the global growth generator
countries [1] apart from their association in Brazil, Russia, India, China, and South Africa.
Mohanty and Klau (2001) called the steady transition of the inflationtostablelevelsaswellas
monetary policy preference for inflation targeting as the two prominent developments of the
monetary sectors in EMEs during the 1990s. [2] According to them, information regarding factors
determining inflation in these economies serves as a precursor for a better understanding of
monetary policy in EMEs. The empirical literature also articulates the key role of fiscal dominance
and exchange rate channels in forming inflation expectations in such economies. Although India
adopted a flexible inflation targeting (FIT) regime no sooner than 2016, People’s Bank of China
(PBC) does not explicitly target inflation till date; still the issues surrounding the causes of inflation
and whether such pressures stem from thefiscal side of the policymaking are pertinent considering
the fundamental role that these economies play in driving the growth story of Asia.
1.1 Inflationary trends in India and China
Price stability is an important goal of the monetary policy in both India and China. Reserve
Bank of India (RBI) in India has specifically movedfrom multiple indicator approach to FIT
regime based on headline consumer price index (CPI) after the recommendations of the
Expert Committee to Revise and Strengthen the Monetary Policy Framework (the Expert
Committee) which submitted its report in 2014 (RBI, 2014). While China’s central bank, the
PBC does not explicitly target inflation; the State Council, China’s primary administrative
authority, does announceyearly targets for CPI along with the targetof economic growth.
The inflation pattern as exhibited by CPI in both the economies is reflected in Figure 1.
The trajectory of inflation throughout indicates that CPI (India) is above CPI (China)
consistently after 1996–1997. The period before that saw CPI (China) touching above 15%
level between 1987 and 1989 and 1993 and 1995 majorly because of the liberalisation
Figure 1.
Annual inflation–
India and China (CPI) –5
0
5
10
15
20
25
30
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
CPI (China) CPI (India)
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