Indian Journal of Finance

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Indian Twin Deficits: The Role of Inflation and Money Supply


Affiliations
1 Assistant Professor, Symbiosis Institute of Business Management, Pune, Symbiosis International University, Lavale Gram, Mulshi Taluka, Pune - 412 215, India
2 Assistant Professor, Symbiosis Institute of Business Management, Pune, Symbiosis International University, Lavale Gram, Mulshi Taluka, Pune - 412 215, India
3 Doctoral Student, Ecole d'économie de Toulouse, Manufacture des Tabacs, 21, Allée de Brienne 31015 Toulouse Cedex 6, France

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The study explored the role of inflation and money supply in the twin deficits hypothesis using the IS-LM framework and posited that inflation could be the mediating variable which explains why a higher fiscal deficit may lead to worsening of the current account balance. This may hamper the effectiveness of the monetary policy and long run output growth. We tested the model empirically on Indian data using Johansen's cointegration test to find evidence that fiscal deficit, current account deficit, inflation, and money supply have a long-run relationship.

Keywords

Twin Deficits Hypothesis, Mundell-Fleming Model, Inflation, IS-LM Model, Johansen Cointegration, Fiscal Deficit, Current Account Deficit.

E6, H2, H5, H6

Paper Submission Date: August 5, 2015 ; Paper sent back for Revision : November 17, 2015 ; Paper Acceptance Date : January 4, 2016.

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  • Indian Twin Deficits: The Role of Inflation and Money Supply

Abstract Views: 184  |  PDF Views: 0

Authors

Madhura Bedarkar
Assistant Professor, Symbiosis Institute of Business Management, Pune, Symbiosis International University, Lavale Gram, Mulshi Taluka, Pune - 412 215, India
Santosh Gopalkrishnan
Assistant Professor, Symbiosis Institute of Business Management, Pune, Symbiosis International University, Lavale Gram, Mulshi Taluka, Pune - 412 215, India
Kunal Khairnar
Doctoral Student, Ecole d'économie de Toulouse, Manufacture des Tabacs, 21, Allée de Brienne 31015 Toulouse Cedex 6, France

Abstract


The study explored the role of inflation and money supply in the twin deficits hypothesis using the IS-LM framework and posited that inflation could be the mediating variable which explains why a higher fiscal deficit may lead to worsening of the current account balance. This may hamper the effectiveness of the monetary policy and long run output growth. We tested the model empirically on Indian data using Johansen's cointegration test to find evidence that fiscal deficit, current account deficit, inflation, and money supply have a long-run relationship.

Keywords


Twin Deficits Hypothesis, Mundell-Fleming Model, Inflation, IS-LM Model, Johansen Cointegration, Fiscal Deficit, Current Account Deficit.

E6, H2, H5, H6

Paper Submission Date: August 5, 2015 ; Paper sent back for Revision : November 17, 2015 ; Paper Acceptance Date : January 4, 2016.




DOI: https://doi.org/10.17010/ijf%2F2016%2Fv10i2%2F87231