Fiscal Stance and Macroeconomic Stabilization: Evidence from Indian Subnational Governments
Against the backdrop of fiscal rules-based legislation in India, this paper examines the link between the fiscal stance and the output gap to analyze if India experiences Keynesian countercyclicality of fiscal policy. The fiscal stance is constructed as the deviation between the actual fiscal deficit and the cyclically neutral fiscal deficit. The output gap is obtained from applying the Hodrick-Prescott (HP) filter to the state-level GSDP variable. Using the System generalized method of moments (GMM) across 27 Indian states for the period 2014–15 to 2023–24, we examine the countercyclicality possibilities controlling for political economy variables, COVID-19 shocks, and debt deficit dynamics. The results revealed that the fiscal stance exhibits substantial persistence and there is countercyclicality when controlled for debt dynamics and pandemic shocks. The policy implications of our results emphasize the significance of fiscal policy in the macroeconomic stabilization function and demand management in times of crisis and uncertainty.
