Does Fiscal Policy Stabilise or Amplify the Cycle? Evidence from Indian Subnational Governments

Gaidimlung K Jacob and Lekha Chakraborty, TTPI Working Paper 19/2026 October 2026
 

Abstract

Against the backdrop of fiscal, rules-based legislation in India, this paper examines the link between fiscal stance and the output gap at the state level in India. We ask whether Indian states experience Keynesian countercyclicality in their fiscal policies. The fiscal stance is constructed as the deviation between the actual fiscal deficit from the cyclically-neutral fiscal deficit. The output gap is obtained from applying a Hodrick-Prescot filter to state-level Gross Domestic Product. Using System GMM across 27 Indian states for the period 2014–2015 to 2023–2024, we examine the countercyclicality possibilities controlling for political economy variables, the Covid-19 shock and debt deficit dynamics. Fiscal stance exhibits substantial persistence and is not pro-cyclical. The empirical evidence suggests a mild countercyclicality after controlling for political economy variables, debt dynamics and pandemic shocks. The results suggest that fiscal policy can be effective in macroeconomic stabilisation function and demand management in times of crisis and uncertainties.