Books and in Books

Ashima Goyal, (1995), 'Foreign Inflows: Evil, Blessing or Opportunity?' in K. S. Parikh (ed.), Mid-Year Review of the Indian Economy, 1994-95, Konark Publishers Pvt. Ltd., New Delhi.

Under the spurt in foreign inflows, as occurred in the nineties, the exchange rate tends to appreciate, which can hurt exports. Volatile short-term inflows are undesirable. Large-scale foreign inflows can only be sustained if both output and exports are rising. A brief review of theory and country-experience is undertaken to suggest policies to maximize benefits. Rising global interpenetration leads to limitations on traditional monetary and fiscal policy. If the real exchange rate is fixed by a desire to maintain export competitiveness, monetary policy looses effectiveness. Fiscal policy is also limited, as the fiscal deficit becomes an adverse signal variable to the global investor.

The small feasible set, of policy actions, are those that increase the rate of growth, enhance individual incentives and work with market trends. Among these are tax/tariff and interest rate incentives for private investment and a rise in public investment in infrastructure. In a more open economy policy can work with international arbitrage to reduce domestic real interest to the world interest rate (assuming fixed exchange rates and similar rates of inflation). Foreign inflows make it feasible to fund such policies. Labour-intensive infrastructure investment would directly benefit the poor through expansion of employment and indirectly through a rise in agricultural productivity and exports, a fall in inflation through beneficial supply side effects, would allow an even larger decrease in nominal interest rates, and raise export competitiveness. Disinvestment of equity of public sector enterprises gives an opportunity to restructure, deepen primary issue markets, and increase public investment in desirable directions, while maintaining fiscal discipline. As interest rates fall and profit rates rise the proportion of more stable FDI in the inflows should rise. Foreign direct investment could come in to fill any gap between I and S as long as the expected rate of profit was greater than world interest rates.

Ashima Goyal, (1997), "Inflation, Exchange and Interest Rates; A Macroeconomic "Rashomon"", in the India Development Report, ed. by Kirit S. Parikh, IGIDR and Oxford University Press.

Conflicting interests are often the reason for conflicting interpretations of the complex interactions between inflation, exchange and interest rates. This paper seeks to identify the set of growth-stimulating policies that can best reconcile these. Nominal interest rates rise when inflationary expectations (p e) or expected real interest rates (re) are high. If money supply rises by too much, p e rises, if it falls by too much, re rises. An expected depreciation of the exchange rate occurs, if p exceeds world inflation or if r exceeds world interest rates. Therefore a fine balance is required in money supply growth. A good way to achieve this is targeting the real interest rate along with supply side policies to lower p e. The structure of the Indian economy where inflation is highly responsive to food prices, and an inverse relationship is observed between growth and inflation, makes this feasible. Other policies required are reduction of revenue deficits, expansion of public investment in infrastructure, and use of flexible instruments such as refinance by the Reserve Bank. The real exchange rate would then hold steady, and foreign direct investment would safely fill resource gaps.

Apart from inflation, the other factor making for a rise in interest rates is government borrowing. But interest rates lower than growth rates are essential to avoid a debt trap and can be sustained if the government lowers the revenue deficit, and uses borrowings for productive investment. One reason for the damaging stickiness of high interest rates over 1995-96 was the perception that government borrowing was and would remain high. This led to an expectation of high interest rates in the future. Banks borrowed long-term at high interest rates, this pushed up their costs and made them slow to lower lending rates even when liquidity improved. But Government borrowing from banks was actually below trend during that period, and cannot be blamed for high interest rates. Moreover from November 1995 the RBI lowered the CRR, easing liquidity. But biased popular perceptions can also be self-fulfilling. Stock market indices remained low, illustrating the inverse relationship between asset prices and interest rates, and adding to the squeeze on availability of funds. The speed of price adjustment in financial markets is now much faster than in goods markets, and quicker reaction, is required, to market information embodied in nominal interest rates. Monetary tightness can cause expected depreciation as equilibrium real exchange rates depreciate with low growth.


Ashima Goyal, (1997), 'Foreign Capital and Economic Liberalization: Cooperation or Competition?' in Kousar J. Azam (ed.), Economic Liberalization in India: Implications for Indo-US Relations, American Studies Research Centre, Delhi: Delta Publishing House.

Entry of foreign direct investment is one of the key issues in the current liberalizing reforms. Under neoclassical growth theory the contribution of capital to growth is small and therefore that of foreign capital is even lower. More recent theoretical developments suggesting that it can be quite large are surveyed. Foreign capital is said to enhance competitiveness and therefore efficiency. But we argue that the full benefits of such entry will take place only if cooperation rises. If competition gives an impetus to growth it would make more co-operation possible. But there do exist a set of actions that would encourage the latter. These include (i) long-term commitment by foreign capital manifested by investing in local communities and adapting products to local preferences, (ii) implementation of stimulatory government policies that raise both demand and supply and encourage individual initiative, and finally, (iii) regulation to maintain an even balance of power and prevent exploitation. People will seize the opportunities presented by the lifting of the "do nots" and rise above the pettiness and counter-productive norms of interaction they had caused.


Ashima Goyal, 1999, `The Political Economy of the Revenue Deficit' in the India Development Report, ed. by Kirit S. Parikh, IGIDR and Oxford University Press.

A widely accepted hypothesis is that concessions demanded by and granted to vested interests are responsible for the steady decline in the government financial position. We argue that it was rather the supply-side shocks of the seventies combined with the political objective of protecting the poor that were responsible. We support our argument by examining time series of disaggregated government budget data, and the theory of incentives under imperfect information. The latter suggests that price controls in the presence of cost shocks would lead to systematic incentives to lower quality and investment. And therefore lower tax capacity and the ability to reduce poverty in the future. We illustrate these mechanisms at work in power, telecommunications, railways, roads, education, and tax collection. The analysis is hopeful, however, because if this causal mechanism were understood, a concerted attempt to rationalise user charges and improve quality would be more acceptable. The process would be helped by macroeconomic policies that keep interest rates low and prevent exchange rate volatility, while supply side policies keep inflation low.


Ashima Goyal, 'Reform Proposals from Developing Asia: Finding a Win-win Strategy'

Recipient countries and creditors have different perspectives on proposals for reform of the international financial architecture. The difference arises from varying perceptions of the causes of the Asian crisis. Creditors emphasize inappropriate policies of borrowing countries, and inadequacies in financial sectors. Recipient countries point to evidence of incorrect monetary policy advice, of contagion and herd behavior. If reforms include items from both sets this would maximize future benefits from financial flows. Statements from Asian policy makers and academics indicate that these countries remain committed to globalization and financial reform and are willing to adopt policies from the first set. If the balance of global power allows creditors to escape policies from the second set, it will harm them in the long run. Greater understanding of these technical aspects, stronger Asian regional groups and coalitions with other reformist groups and academics increase the chances of a more balanced set of reforms.


Ashima Goyal, 2002, 'Interest Groups or Incentives: The Political Economy of Fiscal Decay'

One view is that concessions demanded by and granted to interests groups are responsible for steady fiscal decline, and delay in reforms. We argue that negative supply shocks combined with the political objective of protecting the poor can build in incentives leading to these results. Pricing rules for government services, generated in such circumstances, would be equivalent to a fixed price contract that left the government with negative rent. A decline in investment in and quality of government services would follow, since price controls in the presence of cost shocks would lead to systematic incentives to lower quality and investment. Tax capacity and the ability to reduce poverty in the future would fall. The framework helps to understand the Indian experience. Time series based tests of causality support the causal priority of positive cost shocks. If it is accepted that incentives, and not only interest groups are responsible for fiscal decay, a concerted attempt to rationalize user charges and improve quality may be politically feasible.


Ashima Goyal, 2002, 'Coordinating Monetary and Fiscal Policies: a role for rules?'

The chapter is on the coordination of monetary and fiscal policy in India. It examines the ways in which the coordination has changed over the years, with reforms, and opening out. It brings out how it has been influenced by India's history, development needs and political economy. All this in the context of the key theoretical ideas and international experience in this area that brings out the role rules can play.


Ashima Goyal, 2003, 'Budgetary Processes: A Political Economy Perspective'

The response to macro shocks, given the electoral structure, built in perverse incentives that influenced India's development process. The chapter selectively surveys political economic theory, Indian and other country experience to bring out the systemic incentives that affect political behaviour, government budgets, and expenditure. Conceptual categories developed are found useful in interpreting Indian experience. Overtime, conflicts between groups were handled in a way that lowered incentives for expansion of the cake, and led to a short-term focus. Price controls bred inefficiencies, especially after the oil shocks. But there are leverage points for change. Well-coordinated macro policy, including infrastructure spending, with some restraints on political-bureaucratic choices, could create incentives for rapid growth. The latter eases political adjustments. It makes longer-term sustainable re-distribution feasible, and raises returns to choices that improve human capital.


Ashima Goyal, 2004, 'Getting Water from Public Private Partnerships'

The paper explores contractual types of public private partnerships that would deliver maximum value in the Indian context. Under incomplete contracts social institutions, tailored to the specific context, can contribute to effective governance. We first draw out some implications of contract theory, then examine recent international experience with PPP in water supply, and finally draw upon all these to illustrate how services from public utilities, specifically from Mumbai's water supply, can be improved, with cost saving through the reduction of waste. While assets should continue to be in public hands, well-designed service contracts would improve coverage, consumer orientation and low level accountability which is missing in public provision; reduce wastage; encourage competition and entrepreneurship; achieve financial viability; and develop a thick network of low-risk credit-customers for banks and financial institutions. They would, however, require support from price reform, independent regulators, and user groups. Citizen groups can use voting power to motivate politicians to shift from direct subsidies and hidden costs to the delivery of quality services. Some specific issues in water supply reform are that the easy availability of quantity rationing in public water supply perpetuates low quality and distorted prices, and heavy use of non-transparent taxes and fixed charges lowers efficiency and welfare. It follows that re-balancing between fixed and volume charges would contribute to welfare and improve quality.


Ashima Goyal, 2004, 'Puzzles in Indian Performance: Deficits without disasters'

The paper explores puzzles in Indian growth performance such as the prolonged period of below potential growth in the late nineties. Uneven behaviour of investment was a major explanation. Risk aversion and adverse expectations prevented investment from rising. The high fiscal deficit is often blamed, but since sufficient domestic and foreign savings were available to compensate for government borrowing, the high fiscal deficit did not crowd out private investment or raise risk and interest rates. A sign of the absence of excess demand was that the fiscal deficit did not lead to a current account deficit. The problem was that, partly because of structural rigidities, monetary-fiscal policy was unable to create the conditions to absorb the foreign savings made available. High volatility in nominal interest and exchange rates raised risk and amplified exogenous shocks. The second factor raising uncertainty was that exposing manufacture to international competition was delayed too long. The fear of future competition initially caused paralysis from perceived risk, but as it started materializing by 2003 lowered cost, improved quality and competitiveness. The fall in bank loans and slump in stock markets also contributed to perceptions of higher risk, but may have been part cause and part effect of the slowdown. A reduction in real interest rates and a rise in growth is an effective way to reduce government deficits. It was the contrary movements in these two variables that were responsible for rising fiscal deficits in the late nineties. The smooth fall in Indian nominal interest rates after 2001, and rise in infrastructure spending, succeeded in stimulating higher industrial growth by 2003, even though inflation fell even faster so that real interest rates remained high. Macropolicies need to be designed to lower volatility in key macroeconomic variables and market mechanisms developed to lower the impact of volatility on firms and households. Such policies can stimulate growth, make it easier to undertake deep reform, and the latter can reinforce growth, allowing it to reach potential.


Ashima Goyal, 2004, 'Foreign Investment in India: riding the wave'

A careful examination of the potential impact of different categories of foreign investments allows implications to be drawn for actions of governments and of investors, which have the potential to increase the amount and maximise welfare from such investment. Conceptual issues are emphasized, illustrated with the Indian experience, and some international comparisons made. In India the pull factor attracting FDI has been intensifying. FDI has contributed to improvements in industrial processes, qualities and standards. There is a consensus about FDI's desirability. Regulation changes have taken place, at the central and state levels, with the objective of smoothing the entry process. Other inflows have shown more volatility, and their contribution has been less than potential, because macroeconomic policies maintained a large and volatile interest rate differential. As a result investment fluctuated, and inflows fed a large forex reserves accumulation. A softening of interest rates and strong infrastructure spending has stimulated an industrial revival, so that India seems to have succeeded in triggering a virtuous cycle in 2003, that spillovers from foreign inflows help make possible.


'Exchange Rates, Food Price Stabilization & Inflation'

Food price stabilization is essential in developing countries to provide food security and incentives for farmers. But some of the means used are inefficient and others lend themselves to capture by interest groups. Two changes suggest a possible new solution. First, trade at the margin in agriculture should rise with new agreements under WTO. Second, the currency crises of the nineties have shown the superiority of a managed float for developing country exchange rates. If the exchange rate has to be managed, one way to do so is to vary the nominal exchange rate to partially neutralize variations in world food prices. This combined with more liberal agricultural trade, can help to stabilize agricultural prices, lower the dependence on the other more distortionary policies, and provide a possible resolution for political deadlocks that make it difficult to remove subsidies. The benefits for macroeconomic policy come from inflation stabilization, more degrees of freedom, and exchange rate behaviour that reduces currency risk. An analysis of Indian experience in the nineties suggests that the rule would have been beneficial.


'Global Sourcing: East-West Divide or Synthesis?'

This chapter shows that ICTs make possible a more inclusive global trade, since now labour intensive components of production can be unbundled and sent where it is cheaper. The new mobility of virtual labour, together with the rise in capital mobility, will lead to a wider diffusion of benefits. ICTs reduce frictions and search costs in labour markets, and allow access to new hitherto excluded segments, whether firms or workers in developing countries or women. The smaller scale of efficient production induces more entry of new firms, thus raising wages and employment more than profits, and benefiting workers. Higher levels of employment and learning-by-doing can, in turn, induce more labour using technological progress and further raise both productivity and wages. Policy that targets education and training of workers and reduces barriers to the entry of new firms can minimize underinvestment and short-run job loss for developed country workers.


'Hedging and Indian Foreign Exchange Markets'

The paper examines what hedging of currency risk is, how it differs from speculation or arbitrage, how it is done, and why it tends to be incomplete. The reasons for the latter are incentives due to exchange and interest rate policy, and regulations; psychological attitudes; special features of foreign exchange (forex) markets including uncertainty in fundamentals and a tendency to overreact. A common regulatory response to malfunctioning is to impose quantitative restrictions, but this impedes the development of financial markets, their functioning and potential benefits. Alternatively, it is possible for policy to improve incentives for hedging, through appropriate regulation, macroeconomic policy, and attention to the psychology of market players. New technology facilitates such policy. The Indian experience with forex market reform is used to illustrate the arguments.


'Macroeconomic Policy and the Exchange Rate: working together?'

The chapter reviews the behaviour of the Indian exchange rate over the past few years, and its interactions with the macroeconomic cycle. It examines the extent to which exchange rate policy has been able to contribute to lowering the probability of currency and banking crises, ensuring sustainable internal and external balance, and containing inflation. Given the political economy, more openness, the structural wage-price processes, the degree of backward and forward looking behavior in the Indian economy the chapter draws out implications for macroeconomic policy. It finds that structure combined with openness actually increases the degrees of freedom and impact of monetary policy.


Ashima Goyal, 'Developing Economy Macroeconomics: Fresh Perspectives' Allied Publishers, New Delhi, 1999.

The book develops an analytical frame suitable to analyze macroeconomic issues in developing economies (DEs) such as India, and applies it to understand the post reform period. Structuralist macrotheories have institutional detail, which makes them relevant for the analysis of developing economies. But their behavioural functions are ad hoc. Restrictions on the mark-up from the firm's dynamic optimization give a micro foundation for structuralist economics, and allows an endogenous switch from low to high medium-run growth paths and vice versa. Development economics has long analyzed virtuous and vicious cycles and underdevelopment traps. But these concepts have never systematically been used to understand the macroeconomic performance of DEs. The book attempts this. The poor utilization of resources implied by underdevelopment also represents an opportunity. A DE with labour employed at low productivity is resource constrained, but growth can be investment led with a high growing modern sector able to pull resources from others, and from abroad.

The model is calibrated in the prior period, simulated for the nineties, and projections and policy recommendations made. The reform process is broken into its constituent shocks and their interactions and effects on the medium-run growth paths is analyzed. Efficiency rose after the reforms, but macro policy has delivered negative shocks such as a fall in demand and investment and a rise in interest rates. The traditional macro adjustment prescribed for a supply shock is to lower demand. But in a DE, the composition of demand matters for growth and future supply. A fall in investment in response to a supply shock can harm both. Macro adjustment in such an economy has to be subtler. A contraction in demand, or rise in real interest rates, can amplify supply shocks and lead to a fall in growth. If a demand stimulus switches the economy to a high growth path, it will not be inflationary, because of the inverse relation between growth and inflation in the medium-run.

The simulations show that before the mid-eighties the causes of inflation were supply shocks and trend changes in the mark-up. Productivity largely influenced real wages; but in the nineties structural changes in the conditions of supply can facilitate a fall in core inflation. Projections are made till the year 2000, and give the behaviour of key variables under alternative high and low growth scenarios. They indicate clearly that the major cause of the fall in inflation from 1996 was the fall in desired mark-ups due to restructuring and high growth. The flip side is that on the low growth scenario, mark-ups start to rise in 1998 and so does inflation.

Project Reports

Ashima Goyal, (1996), "Consistency in Financial Sector Reform" in ICEG/ICRIER sponsored project on 'Financial sector reforms in India' Report presented in February 1996.

survey of country experience and theory shows that financial deepening turns out to be a necessary adjunct of development, but reforms need to be designed to be consistent with other policies, domestic institutions and their feasible evolution. With the current structure of Indian financial sectors, deregulation is likely to raise interest rates, because of both macro policies and micro incentives. Some financial sub-markets lack depth or are missing. Futures and other instruments that are good hedges against fluctuations in interest, exchange rate and inflation are underdeveloped. This, abetted by paucity in their variety and volume, can lead to bubbles in the prices of financial and other more traditional assets. Therefore a complementary set of four policies is required: easing the supply response of assets; non-discretionary regulation and prudential norms to guard against malfunction; targeting a small positive real interest rate by using market instruments; and other steps to raise physical investment. The rate of interest plays a major role because a rise in it can induce a fall in asset prices, lead to a financial panic, and harm real activity. As the present value of future discounted output falls, investment and asset prices are lowered. Specific policies tailored to lacunae in the Indian financial sector include:

1. Increasing the number of players in the market and its depth, and improving informational efficiency can lower market manipulation.

2. Markets in transition often have special problems. Excess volatility can be caused by a sudden influx of new entrants such as FIIs-a carefully phased capital gains tax can help. Tighter non-discretionary regulation combined with measures to improve incentives for physical investment and financial savings, and raise the supply of financial assets, are a good way of reducing the returns to speculation. Transaction costs must be lowered and artificial restraints on movement of funds removed.

3. Automatic mechanisms such as circuit breakers and margin rules can be used to moderate the tendency for cumulative movements in asset prices away from fundamental values.

In Journals

Ashima Goyal, (1992), 'Demand, Supply and Savings Constraints in Indian Economy', Economic and Political Weekly, April 25, pp. 893-899.

This paper develops three model-related criteria to classify the non-agricultural sector of the Indian economy as demand or supply constrained. The savings behaviour of the economy and its measurement is then examined and related to these criteria. It is shown that savings are underestimated. But even so, while a short-run demand constraint held, a longer-run supply or resource constraint dampened investment demand in the late 60s and 70s. Higher public sector investment from the late 70s helped maintain favourable growth dynamics that led to financial deepening and increased flow of resources to productive sectors. But innovative fiscal reform, including sale of public sector enterprises, is required to maintain high new public-sector investment, until growth can become self-sustaining.

Ashima Goyal, (1993), 'The Role of Foreign Aid and the Foreign Exchange Constraint in Growth: Some Extensions', Journal of Foreign Exchange and International Finance, Vol.7, No.1, pp.30-43.

This paper argues for the introduction of separate behavioural savings and investment functions, in analyzing the effect of foreign inflows and the foreign exchange constraint on development. Then the expected negative effect of foreign inflows on the savings function disappears. In the static case aid is most productive when the trade constraint holds. In a dynamic model the maximum contribution of foreign inflows comes from their investment inducing effects. Simulations with Indian data confirm the results and show that foreign inflows are important for continued high growth of the Indian economy in the nineties.


Ashima Goyal, (1994), 'Industrial Pricing and Growth Fluctuations in the Indian Economy', Indian Economic Review, Vol.29, No.1.

A theoretical dynamic macro-model is reduced to a simple two-equation non-linear differential equation system and calibrated with Indian data. The dynamics of mark-up and output are examined to explain and reproduce the secular movements of non-agricultural price and output in India, and test alternative mark-up hypotheses. The simulations show that relative rigidity in mark-up plays an important part in maintaining the historical stable price and output trajectories that approach towards or recede from different possible non-Walrasian equilibria.


Ashima Goyal, (1994), 'Growth Dynamics: in a General Equilibrium Macroeconomic Model for India', Journal of Policy Modeling, Vol.16, No.3.

A dynamic macro-model is used to determine non-agricultural price and output in an agricultural policy applied general equilibrium model for India, with nine agricultural sectors. The model allows simultaneous determination of non-agricultural price, output and capacity, and suggests a solution to the 'macroclosure' problem of applied general equilibrium models. Counter-factual simulations show that household savings rise more than investment on a high growth path, so that the latter can be financed. This occurs because of an endogenous shift of population to higher income groups. The government has to be a large net dis-saver to maintain balance. Rural population in the lower income groups remains unchanged even in the high growth scenarios.

Agriculture has a low supply response, and large price response to rapid growth in non-agricultural output. The terms of trade move sharply against non-agriculture and may even abort the growth process. Agricultural supply responds well to investments in expansion of irrigation and new technology. Counter factual high growth simulations show that public sector investment 'crowds in' private sector investment and is itself 'crowded out' in periods of resource constraint.

Large borrowing by the public sector in the eighties has led it into a position of cumulating unsustainable debt, and there has also been a decrease in the share of public sector investment in agriculture. Apart from other fiscal reform, a disinvestment of public sector enterprises will help maintain high new public sector investment. A larger share of this should be directed to agriculture, for growth and equity reasons. If high growth is maintained the savings to finance the investment would become available.


Ashima Goyal, (1994), 'Developing Economy Macroeconomics: Fresh Perspectives', Economic and Political Weekly, November 26, pp 3041-3052.

Aspects of New Keynesian, Rational Expectation and General Equilibrium macroeconomic theories bearing on dynamics and stability are selectively surveyed. Insights are extracted from these for analyzing special features of a typical developing country. Building on these an analytical frame is presented in which the role of demand and supply factors in India's macroeconomic performance can be consistently examined. Indian macro time series are shown to correspond to growth cycles of such a framework, through calibration and simulation. The mark-up, public and private investment are derived from microfoundations of maximizing behaviour. The relation between short and long run equilibria and medium-run dynamic adjustment paths is explored. Results on the countercyclicality of mark-ups; complementarity of public and private investment; stagflation; agriculture-industry and savings-investment linkages and intersectoral resource flows; income distribution effects; an analytical and empirical classification of demand, capacity and trade constraints; and the productivity of foreign inflows are presented.


Ashima Goyal, (1995), 'The Simple Analytics of Supply, Demand and Structural Adjustment', Indian Economic Review, Vol. 30, No.2, pp.37-56.

The paper does three things. First, builds aggregate demand and supply curves for the non-agricultural sector of the Indian economy. Second, uses these to analyze the effects of demand and supply shocks, including liberalization and structural adjustment. The perspective from the microfoundations of an adjusting representative firm allows us to put some structure on an untidy debate. This way of looking at the problem is particularly apt, as one of the main objectives of the structural adjustment program (SAP) is to lower costs and improve the efficiency of Indian industry. It allows a medium-run focus that is the correct one for an analysis of a SAP. Third, we are able to shed new light on the inflationary process in the Indian economy. The Phillips curve or the relationship between nominal wage inflation, expectations, and unemployment forms an important part of any story of inflation. It is difficult to derive a Phillips curve for a labour surplus dualistic economy. Instead of a Phillips curve type inverse relationship between the rate of inflation and unemployment, we obtain a direct relationship between inflation and the unemployment rate of capital that helps to explain stagflation. As the underutilization of capital increases so does the rate of inflation.

The nominal standard is not money wages but the price of food, which is normally rising in such episodes. As in New Keynesian Theories and consistent with microfoundations of firm behaviour, the relation between nominal (the price of food) and real rigidities (the mark-up) explains inflation. The rigidities create complementarities between key prices, so that they move together, explaining periods of acceleration and deceleration in inflation. The real rigidities are explained by the dynamics of the system.


Ashima Goyal, (1995), 'Putting Structure on Structural Adjustment', Economic and Political Weekly, May 6-13, pp 1013-1020.

It is argued that a framework to appraise the structural adjustment program (SAP) should be based on macroeconomic categories of aggregate demand and supply; incorporate structural features of the Indian economy; focus on the decisions of the firm over the medium-run; and bring out the effects of macroeconomic policies on growth. Analysis with such a framework yields the conclusions that inflation is best managed by a set of policies that stimulate demand as well as supply. Since multiple outcomes are possible, a set of policies that act in concord to push the economy to a better outcome can allow every group to benefit. As the price of food is the nominal standard for the Indian economy, policies that effect the former are particularly important.


Ashima Goyal, (1996), 'Savings in India: When Data are doubted can Theory help?' Economic and Political Weekly, May 25, Vol. 31, 21, pp.1257-1264.

The paper uses a dynamic macro model to shed light on controversies surrounding savings behaviour in the nineties, especially the impact of foreign inflows on savings. Simulations indicate that there was some underestimation of savings in the early nineties, but at the same time, savings propensities fell. The ways in which foreign inflows impinge on savings are examined. If they stimulate growth then savings are higher in periods of rapid growth. But in order to prevent an unsustainable accumulation of debt, it is essential to maintain high incentives for savings and investment, and provide new instruments for both. In the presence of the latter, mobility between income groups augurs well for a future rise in the Indian aggregate savings ratio.


Ashima Goyal, (1996), 'Industrial Pricing and Growth Fluctuations: Some Tests', Economic and Political Weekly, Nov.30, Vol. 31, No. 48 and 19, pp M-54-M-62.

The paper examines the relationship between the mark-up and activity, for disaggregated industrial sectors in India. A dynamic aggregate demand-supply based model, of a representative firm, yields restrictions on the firm's pricing decisions. They allow the specification of a mark-up change equation, from first principles, which is estimated at the two and three digit industry level. The regressions corroborate the theoretical hypothesis. Both short and medium-run mark-up are countercyclical. The short-run response of the mark-up is greater than the medium-run. Conclusions are (i) the conditions for stability are satisfied, (ii) there is some short-run nominal price rigidity, (iii) the mark-up shows only small changes over the medium-run, and (iv) aggregate demand matters for industry supply decisions.

The observed stability of the mark-up provides a microfoundation for structuralist macro theories, and the derivation from dynamics gives a more general justification for mark-up pricing; it is not limited to special industry structures as in Industrial Organization theory. The mark-up affects inflation. Since it is also the profit share, it affects both the savings and investment decisions, and influences medium-run growth or macroeconomic activity. Therefore a demand squeeze can lead to stagflation. Even in the absence of a supply shock, inflation will be higher and growth lower when demand for industrial goods is low.


Ashima Goyal, (1996-97), 'Sticky Relative Prices, Dynamics and the Closure Debate', Journal of Post Keynesian Economics, Vol.19, No.2, pp.195-222.

In an aggregate one good, two-factor model, a simple diagrammatic measure of excess profits is derived. The mark-up is obtained as the shadow price of a demand constraint on sales. It is proved that with excess capacity, a positive mark-up makes the firm indifferent between using capital and holding it underutilized. When investment is exogenous, the mark-up is positive if investment is greater (less) than full employment savings and capital is fully utilized (there is excess capacity).

The model is used to classify theories of aggregate price and output, according to their exogeneity assumptions, or closure rules. The budget constraints of a fully specified general equilibrium system make an equation drop out, leaving one variable free to be determined from outside. The closure rule chosen constrains model results. Dynamic interdependence of the pricing and investment decision, of the firm, with expectations defined over disequilibrium adjustment paths, generate consistent closure rules. The latter provide an explanation for (i) the persistence of excess profits, excess capacity and real price rigidities, (ii) low price and substitution effects compared to income effects, and (iii) pro-cyclical real wage movements.

The firm is on its factor demand curve but the aggregate labour demand curve is not well behaved. The wage share rises in periods of high investment led growth. Variations in the labour-capital and wage-rental ratios alone are insufficient to restore product-market equilibrium. Changes in output and resource utilization are also required. Complementarily rather than substitutability relations between inputs dominate, and demand plays a central role even though full substitution among factors is possible on the supply side.


Ashima Goyal, (1997), 'Financial Reforms: Why Interest Rates Must be Kept Low' International Journal of Development Banking, Vol.15, No.2, July-Dec.

An inter-country comparative analysis of financial reform reveals that the countries that have maintained flexible nominal and low positive real rates of interest have been the most successful. Regressions indicate that financial deepening is demand induced, and is inevitable as growth and globalization brings complexity. Some distinguishing features of the Indian financial sector are the very high share of the public sector in total credit; comparatively high broad and narrow money ratios; and sophisticated stock market. The strengths make financial deepening possible and the weaknesses indicate the required direction of change. The poor portfolio of assets available for risk diversification was one reason for widespread government intervention: government supported institutions and assets continue to perform better in financial markets. Therefore the provision of risk sharing and hedging instruments should be accompanied by macropolicies that keep real interest and exchange rates relatively constant while allowing some nominal variation. The instruments will provide the means for diversifying risk; the nominal variation the motive; the constancy in real prices will lower the possibility of financial panics; a gradual retreat of government from active participation will become possible.


Ashima Goyal, (1997), 'Foreign Capital Inflows, Real Exchange and Interest Rates: an Analytical Framework', Journal of Foreign Exchange and International Finance, Vol.9, No.3, pp.215-232.

We build a framework to explain surges in capital flows, volatility in real exchange and interest rates and derive effective macro policies for an open economy. Our framework is adapted to the features of a labor surplus developing country with a large share of non-traded goods, and focuses on the medium-run. Movements in expected and actual real exchange rates reinforce those in normalized output and inflation and lead to classes of high and low growth equilibria. In such circumstances monetary tightening, following on a supply shock or surge in foreign inflows, can lead to an overshooting of the real rate of interest or the exchange rate and raise inflation from the supply side. This is the reverse of monetary theories of the exchange rate where oversupply of money is associated with inflation and depreciation. What little empirical support monetary theories have found is only for the very long run. Careful coordination of monetary and fiscal policies can shift the economy to the high growth path and minimize fluctuations.


Ashima Goyal, (1997), 'Savings: A Clarificatory Note', Economic and Political Weekly, September 13, Vol. 32, 37, pp 2362-2364.

We elaborate on some issues that are relevant to the ongoing debate on the measurement of savings; and point out a conceptual error in the treatment of foreign inflows in the national accounts statistics. There is double counting of net factor income paid abroad (such as interest payment on debt), since this enters both the measured gross domestic savings and the net capital flows that are added to savings to determine the Gross Domestic Capital Formation. Simple theoretical macro identities are used to help unravel the complexities of the national accounts. In our view transfers that, by definition, do not require repayment in the future should continue to be placed in the current account of the balance of payments.


Ashima Goyal and Shridhar Dash, (1998), 'Arbitrage: an Explanation for the South-east Asian Crisis and Indian immunity',

In many South-east Asian countries, the short-term bank lending interest rate significantly exceeded the US rate through the nineties. This interest differential exceeded the change in nominal exchange rates over the period. Country risk was low because growth was high. Governments committed to stimulate exports would not allow an appreciation of the exchange rate, and the large foreign inflows ruled out an immediate depreciation. Therefore private corporations and banks had a large incentive to borrow abroad in the short-term without hedging. But because medium-run expectations of depreciation had to be positive, to satisfy arbitrage, and equilibrate domestic to foreign returns, the economies were susceptible to shocks. This together with financial market weaknesses explains the rapid collapse after mild external shocks. In monetary theories of exchange rate determination, the currency depreciates under excessive money growth. We demonstrate conditions under which an expected depreciation of the exchange rate can occur under low monetary growth. Tight money policy and a high revenue deficit kept Indian interest rates far above foreign and triggered an industrial recession in 1996-97, and a depreciation of the exchange rate. But during the onset of the South-East Asian crisis monetary policy had been relaxed. This helped India escape the crisis. Other implications of our analysis for Indian economic trends are explored.


Ashima Goyal, (1998), 'Do Foreign Inflows Let Expectations Dominate History', Journal of Foreign Exchange and International Finance, Vol.10, Oct-Dec.

Investment is a function of the present value of expected future output. A change in the regime of foreign inflows can boost these expectations, so that investment propensities exceed savings. A pricing rule exists that ensures stability and maximises expected profits. A macro dynamic system results in which there are two classes of equilibria, with high (low) capacity utilization associated with lower (higher) mark-ups. There are unique classes of adjustment paths approaching these equilibria, and medium-run growth cycles occur due to switches between these. Expectations can jump to either equilibria, causing an endogenous amplification of shocks. Growth cycles are explained by the interaction of history and expectations. The model gives an explanation for macro puzzles such as the reconciliation of excess volatility in quantities, pro-cyclical real wages, and excess capacity, with maximization of expected profits. It provides a justification for stimulatory fiscal policy. The mark-up rule allows only small counter-cyclical variations in the medium-run mark-up but makes large quantity adjustments possible without instability. In the case of a shock to foreign inflows supportive macroeconomic policies that tie the domestic to the world interest rate are required to achieve the highest feasible growth path.

Labour Market Institutions, Real Wages and Macroeconomic Outcomes.

Labour institutions influence the outcome of macro policies. We postulate that, for India, nominal wages rise with average labour productivity and with the price of food, and discuss the macroeconomic consequences. As inflation is caused by sectoral supply constraints and productivity mismatches, a cut in demand need not work, and even if it does, it imposes a large cost. Stimulatory macro policies can actually lower the rate of inflation, and raise real wages, even in the face of a supply shock if they are designed so as not to hurt the productivity increase that is a part of development. A rise in agricultural productivity turns out to be the best way to lower inflation, and allow target real wages and growth in industrial output to be achieved. Greater openness offers a way to follow such policies even in the short-term by using imports to enhance food availability following an agricultural shock. Stylised facts and simulations with a macrodynamic model provide evidence in support of such wage behaviour. A preliminary examination of Indian labour market institutions also supports the latter and suggests that better ways to improve labour's position are better education and training facilities, and infrastructure.

Ashima Goyal and Shridhar Dash (2000), 'Real-external-financial sector interaction under liberalization in an open developing economy',

A short-run model incorporates instantaneous portfolio equilibrium with macroeconomic flows to clarify the structure of real-financial sector interactions. If equity and foreign exchange markets are introduced in structuralist theories of asset markets in developing countries, the key result that a fall in money supply raises the rate of inflation now holds only under special conditions on partial derivatives. But there is a tendency for interest rates to rise and for fluctuations in asset prices. Fuller integration of asset markets moderates these fluctuations. Outcomes are stable in spite of the generalized complementarity distinguishing equity markets from loan markets. Expectations play a major role. Implications for policy are to link domestic interest rates to foreign, remove artificial barriers to market integration, and stimulate demand as well as supply.

Ashima Goyal and Shridhar Dash, (2000), 'The Money Supply Process in India: Identification, Analysis and Estimation'

A new specification is employed to test for the degree of endogeneity of commercial bank credit, and its response to structural variables relevant to the Indian context. Our specification allows us to both identify money supply in a single equation, and disentangle the contribution of the Central and the Commercial Banks to the money supply process. Bank credit reacted more to financial variables and had dissimilar responses to food and manufacturing prices and output. Instead of interest rates, sectoral returns played a major role. Monetary policy broadly succeeded in preventing an explosive growth in money supply and reined in inflationary expectations. But by targeting manufacturing prices it harmed real output. The estimated structure implies that it would be more efficient to target agricultural prices for inflation control. A monetary contraction should be completed earlier than in the past, and should coincide with a rise in food prices. Information available in the systematic structural features can be exploited in designing monetary policy.


Stabilising but continuing to grow: a review article

Macroeconomic analysis has been neglected in development texts but the major exciting questions in the nineties such as stabilisation, liberalisation, structural adjustment, financial crises, and the political maneuvers they give rise to, require a good understanding of macroeconomics. The book covers a gap in the literature. As the number of major questions requiring macroeconomic analysis has risen, macroeconomics itself has moved from a preoccupation with ideological debates and conflicts between different schools of thought, towards focusing on substantive issues and eclectically choosing the best tools and models for analysis. The book is a good example of such an endeavour, and heralds that Indian macroeconomics has become international, with the opening of the economy. The substantive contribution is to make the Bank-IMF model more relevant to context. We draw out the consequences of pushing this further: of differentiating between Latin America and Asia, learning from the East Asian crisis, and new research in choosing the appropriate model closure.

Agriculture and Industry: enhancing mutual gains

There are strong links between agriculture and industry. But does low or high improvement in agricultural productivity give the fastest overall development? In a structuralist two-sector model, the answer is that it depends on the food budget share. An efficient real wage results in a target for the agricultural terms of trade. If relative agricultural price lies above the target inflation occurs. Optimal policies, at high food budget shares, are keeping food prices stable, raising agricultural productivity and industrial demand. A nominal agricultural price rise may lead to a worsening relative terms of trade and lower farm incomes. East Asian economies got the transition right, but in India political economy factors forced an early rise in food prices. Liberalisation offers an opportunity to shift to the optimum policy set. The shift will be more feasible if corporates invest in agriculture. This will increase agricultural productivity, and help revive industrial growth.

`The Impact of Structure and Openness on the Causal Ordering of Inflation, Exchange and Interest Rates in India'

In a country with a very large population at low per capita income, the interaction between the price of food and wages is a major determinant of inflation. But, with liberalisation, as agricultural prices approach border prices, the exchange rate influences the inflationary process. The gap between the actual exchange rate and the exchange rate that satisfies a wage target affects inflation. Thus supply side influences dominate the inflationary process. Then monetary policy acts upon interest and equilibrium exchange rates, thus influencing expected depreciation. Key results are that monetary tightening, in the face of a supply shock, can lead to an expected depreciation of the real exchange rate. Equilibrium real appreciation occurs if net investment rises, and rising agricultural productivity raises the feasible non-inflationary exchange rate, and real wages. The analysis of the interaction between agriculture and industry changes, since agricultural markets adjust to equilibrium through quantities rather than prices. The framework is found to be usefully in interpreting a narrative history of recent macroeconomic trends in India.

'Women Making Choices: Masked but Aware'

Sen's capability approach is very useful to analyze how choices affect potential functionings for women, once the position that women lack self-awareness when they make their choices is dropped. Such a position implies an underestimation of women's agency and potential, and of the need for a larger social emulation of their choices. Women's other regarding choices are not irrational because altruism has value in itself; it also has instrumental value as a source of social capital; it may raise some types of freedoms making it broadly rational. It may even be narrowly rational in the sense of maximizing own utility. The mask of conformity women wear can be misinterpreted as lack of awareness but is due more to the process of development, which increased the relative return to activities outside the home, leaving women with low bargaining power. Potential tests for the depth of the mask are the rapidity with which women make use of opportunities that suit their other regarding choices and the special functionings they have developed as a result. Two such opportunities are new technologies that allow flexible working, and micro-credit institutions targeted at women. Even poor and illiterate women have responded rapidly to these, providing evidence of a shallow mask.

'Transitional Exchange Rate Policy in a Low Per Capita Income Country'

The equilibrium real exchange rate is determined by a sustainable balancing of the current and capital accounts of the balance of payments, in an intertemporal optimizing model. A real wage target gives a target real exchange rate target, which will be more appreciated than the real equilibrium exchange rate, when labour productivity is low. In this case, under high global capital mobility and managed exchange rates, a rise in expected depreciation of the exchange rate is associated with a fall in money balances. Real fundamentals decline and are made worse by monetary tightening, while cost driven inflation continues since the inflationary gap rises. The actual exchange rate approaches the target exchange rate and the widening gap between the actual and the equilibrium exchange rate raises domestic interest rates, lowering investment and productivity. In the context of freer trade, a rule that changes the nominal exchange rate inversely to temporary supply shocks driving inflation in international prices, can lower domestic inflation, and free monetary policy to focus on the domestic cycles and narrow the gap.