Liberalization Policy: ‘Fits & Starts’ or Gradual Change in India

Abstract

In this paper we assess the impact of external economic liberalization in India on the transmission of aggregate shocks. We examine the relative importance of domestic and external shocks and capture their feedback effects by estimating an eight variable vector autoregression (VAR) model. We also test two propositions regarding the nature of India's liberalization policy: 1) under intermittency (or ‘fits and starts’) the transmission of aggregate shocks in the post-reform period is compared with two pre-reform periods; and 2) under gradualism the transmission of aggregate shocks over three consecutive episodes of economic reform are compared. Our test first consists of a simple regression analysis using output, interest rates, and prices for India and its world counterparts. The analysis is extended to include dummy variables and distributed lags method. Finally, we apply the recursive regression method and Chow-tests to uncover breaks in the estimated parameters. The preponderance of evidence suggests that India's liberalization policy has followed a continuous and smooth path, at least since the mid 1970s.