Assessing non-linear effects of government size on inflation in India: recent evidence from smooth transition autoregression model

Abstract

Purpose

Standard economic theory predicts that any increase in public spending is accompanied by a rise in inflation in an economy. This paper presents empirical proof that prices do not always rise with an increase in public expenditure but only up to a certain threshold level. The primary aim of this paper is to unearth the government size-inflation nexus in India for the period from 1971 to 2019.

Design/methodology/approach

The logistic STAR (smooth transition autoregression) model is employed to unravel the government size-inflation nexus for the Indian economy from a non-linear perspective.

Findings

The finding of our study confirm the non-linear relationship between the size of the government and inflation in India. The estimated threshold level for government size is precisely found to be 9.27%. The size of the government exerts a negative influence on inflation until it reaches the optimal or threshold level. Any further increase in the size of government beyond this threshold level would result in a rise in inflation.

Research limitations/implications

The findings have implications for the conduct of fiscal policy. Policymakers can increase government spending in a regime of small government size without having any inflationary impacts by generating revenues from taxes and other sources instead of relying much on the central bank. In the regime of a large-sized government, adhering strictly to the discipline in the conduct of fiscal and monetary policies would help curb inflation and enhance growth synchronously, hence alleviating any loss of welfare.

Originality/value

To the best of the authors’ knowledge, this study is an attempt to revisit the government size-inflation nexus in India from a non-linear perspective using the Smooth Transition Autoregression (STAR) model for the first time.

Citation

Tariq, A., Ahmad, M. and Amin, A. (2022), "Assessing non-linear effects of government size on inflation in India: recent evidence from smooth transition autoregression model", Journal of Economic and Administrative Sciences, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JEAS-08-2022-0190