The economics of government deficits: Some alternative formulations with time series evidence.

The dissertation discusses the impact of fiscal policy on the economy and the interaction between monetary and fiscal policies. It examines the reasoning and evidence behind the commonly held belief that public deficits have a retrogressive impact on the economy. The issues being addressed by this dissertation are: whether the recent growth in deficits is due to increase in interest rates or overall government spending; whether the monetary policy response of governments has reinforced or weakened the destabilizing impact of discretionary fiscal policy; and finally, the issue of financing of deficits and its link with inflation. The evidence based on Granger-Sims causality tests, using cointegration and error-correction modeling suggests that the high interest rate regime is largely responsible for the explosion of deficits in the last few decades. Thus, higher deficits do not 'cause' higher interest rates; rather, higher interest rates 'cause' higher deficits because of the central bank control over the rate of interest. In many cases, the high interest rates also 'cause' a decline in public expenditures. Furthermore, the 'monetization' of deficits is not related to the nature of financing of deficits. The evidence supports an alternative notion of 'monetization' (where monetization is associated with aggregate economic activity due to the endogenous nature of the money supply). Such 'monetization', it is argued, has no 'causal' impact on inflation. The analysis of findings for a select group of 11 countries and, in particular for the G-7 countries, strengthen the arguments of heterodox economists, who argue that current fiscal policies of austerity have played a major destabilizing role in contemporary economies. The three essays that constitute this dissertation all highlight the crucial role played by monetary policy in impacting on fiscal indicators in the economy upon which have been fashioned the current policies of fiscal austerity