Page 95 - ES 2020-21_Volume-1-2 [28-01-21]

78 Economic Survey 2020-21 Volume 1

Therefore, a practical fiscal rule should provide wriggle room for fiscal policy to be counter-
cyclical by setting the trigger as a two-quarter slowdown in GDP growth of 3.5 per cent when
compared to the average GDP growth over the previous 20 quarters (2/20 = 10 per cent). As
the average and standard deviation of growth may change over time, this trigger of 3.5 per cent
decline can be reviewed periodically say every five years.

2.45 A counterargument by critics – Paul Krugman’s “deficit scolds” – may be that governments
5
have a natural tendency to spend. So, does the Survey give them arguments to misbehave?
This represents an incorrect interpretation of the Survey findings. The right interpretation is
not to pretend that debt is catastrophic if it is not. The Survey’s effort is thus to provide the
intellectual anchor for the government to be more relaxed about debt during a time of economic
crisis such as the one we are witnessing. Thus, the Survey’s call for a more active, counter-
cyclical fiscal policy is not a call for fiscal irresponsibility. It is a call to break the intellectual
anchoring that has created an asymmetric bias against fiscal policy. Once growth picks up in a
sustainable manner, it will be the time for fiscal consolidation. But, for now, fiscal policy will
have to remain centre-stage to support growth in the foreseeable future.

CHAPTER AT A GLANCE

¾ This Chapter establishes clearly that growth leads to debt sustainability in the Indian
context but not necessarily vice-versa. This is because the interest rate on debt paid by the
Indian government has been less than India’s growth rate by norm, not by exception. As
Blanchard (2019) explains in his 2019 Presidential Address to the American Economic
Association: “If the interest rate paid by the government is less than the growth rate,
then the intertemporal budget constraint facing the government no longer binds.” This
phenomenon highlights that debt sustainability depends on the “interest rate growth rate
differential” (IRGD), i.e. the difference between the interest rate and the growth rate in
an economy.

¾ In advanced economies, the extremely low interest rates, which have led to negative
IRGD, on the one hand, and have placed limitations on monetary policy, on the other
hand, have caused a rethink of the role of fiscal policy. The same phenomenon of
a negative IRGD in India – not due to lower interest rates but much higher growth
rates – must prompt a debate on the saliency of fiscal policy, especially during growth
slowdowns and economic crises.

¾ The confusion about causality – from growth to debt sustainability or vice-versa – is
typical of several macro-economic phenomena, where natural experiments to identify
causality are uncommon. In the specific context of growth and debt sustainability, this
confusion also stems from the fact that the academic and policy literature focuses primarily
on advanced economies, where causality is entangled by lower potential growth when
compared to India. Indeed, the chapter studies the evidence across several countries to
show that growth causes debt to become sustainable in countries with higher growth
rates; such clarity about the causal direction is not witnessed in countries with lower
growth rates. By integrating ideas from Corporate Finance into the macro-economics
of Government debt a la Bolton (2016), the Survey lays the conceptual foundations
to understand why these differences can manifest between high-growth emerging
economies and low-growth advanced economies.

5 https://www.nytimes.com/2016/07/11/opinion/cheap-money-talks.html