At a time when fiscal deficit was burgeoning at 6.8 per cent of GDP, a RBI's occasional paper has made it clear that the government deficit is relevant for stabilisation as expansion of money supply leads to inflation.
The paper which studied impact of government deficit on money in India from 1951-2007, felt that targeting fiscal deficit as tool for stabilisation continues to remain valid.
The study found that there was strong evidence of government deficit leading to reserve money creation with consequent increase in money supply.
The Reserve Bank occasional paper has been authored by economic analysis and policy department directors Jeevan K Khundrakpam and Rajan Goyal. The views expressed are personal and not that of the Central Bank.
The paper also revisited casual relationships between government deficit and money, and money with real output and prices in the country.
It argued that the government deficit will now cause reserve money expansion through the incomplete sterilisation of Net Foreign Assets (NFA) accumulation intended to enable adequate market subscription to government borrowings, replacing the erstwhile channel of net RBI credit to the Government.