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

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Macroeconomic Fallacies

Had interest rates been lower by 3 percentage points over the 1990s, government debt as of March 1999 would have been lower by Rs 1,00,000 crore and the centre's fiscal deficit for 1998-99 narrower by Rs 25,000 crore. The figure would have been larger by March 2000. And would looser monetary policy and lower interest rates have been unacceptably inflationary? Unlikely.

In his article (‘On Some Common Macroeconomic Fallacies’, EPW, April 8, 2000) Prabhat Patnaik comments on what he sees as some macroeconomic fallacies, accepted as gospel truth by our policy-makers. One would like to add to his arguments on some points, and take issue with others.

The first fallacy he discusses is that interest rate in the economy is high because the fiscal deficit is high. He places the responsibility squarely on monetary policy. Going beyond the points Patnaik has made, one feels that perhaps the cause and effect are reverse: that high interest rates are contributing significantly to high fiscal deficits, not the other way round. The effects of high interest rates are both direct and indirect. Since interest is the single largest item of government expenditure, it follows that other things being equal, in a given year, higher the rate higher the deficit as conventionally calculated. But this is only the starting point. This year’s higher deficit adds to government debt – and to the subsequent year’s interest burden, and so on.

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