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Does Growth Lead to Debt Sustainability? Yes, But Not Vice-Versa! 45

Figure 1b: United States (1987 – 2019) Figure 1c: United Kingdom (1987 – 2019)

Source: BEA (US) Source: UK Economic Accounts (ONS) & OBR (UK)

Government net Balance =Total Government Receipts- Public Sector net Balance = Net lending by General
Total Government Expenditure Govt and Public Corporations
Private Sector Net Balance= Gross Private Domestic Private Sector Net Balance = Net lending by Households,
Investment - Gross Private Savings (Domestic business, Non Profit Institutions serving the Households and
households & institutions) private Non Financial Corporations

2.3 While counter-cyclical fiscal policy is necessary to smooth out economic cycles, it becomes
critical during an economic crisis (Box 1). This is because fiscal multipliers, which capture
the aggregate return derived by the economy from an additional Rupee of fiscal spending, are
unequivocally greater during economic crises when compared to economic (Box 2). In a country
like India, which has a large workforce employed in the informal sector, counter-cyclical
fiscal policy becomes even more paramount. In advanced economies, where the public and
private sector labour markets are not too segmented, fiscal spending can increase public sector
employment, reduce the supply of labour in the private sector, bid up wages, and thereby crowd
out private sector employment. However, in a country like India, where the private and public
sector labour markets are largely segmented, such crowding out of private sector employment
is minimal (Michaillat, 2014). Thus, debt-financed public expenditure is more cost-effective to
employ during recessions than during economic booms.

Box 1: Relevance of Counter-cyclical Fiscal Policy

Indian Kings used to build palaces during famines and droughts to provide employment and
improve the economic fortunes of the private sector. Economic theory, in effect, makes the same
recommendation: in a recessionary year, Government must spend more than during expansionary
times. Such counter-cyclical fiscal policy stabilizes the business cycle by being contractionary
(reduce spending/increase taxes) in good times and expansionary (increase spending/reduce
taxes) in bad times. On the other hand, a pro-cyclical fiscal policy is the one wherein fiscal policy
reinforces the business cycle by being expansionary during good times and contractionary during
recessions (Figure A).