The IUP Journal of Applied Economics
The Impact of Domestic and External Shocks on Macroeconomy: A Structural Macroeconometric Model and Simulation Analysis for India

Article Details
Pub. Date : Apr, 2019
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE31904
Author Name : Sajad Ahmad Bhat and Debasish Acharya
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 30



This paper analyzes the impact of domestic and external shocks on Indian economy by constructing, estimating and simulating a small eclectic macroeconometric model, using annual data from 1981-82 to 2015-16. With a satisfactory in sample and out -of-sample forecasting performance, the model has been employed for deterministic simulation analysis. The study evaluates the impact of domestic shock (rainfall shock) and external shocks (oil price shock, world trade shock and reserve bank foreign exchange asset shock) on the economy through various channels. The results reveal that rainfall and oil price shocks are found to reduce the real output both at aggregate and sectoral levels, leading to increase in general price level. Regarding their impact on external and fiscal sectors, rainfall shock is found to have minimal impact, whereas oil price shock is found to have significant impact. Further, reserve bank foreign exchange assets and world trade shock are found to be growth retarding and deflationary in nature. Regarding their impact on the external sector, both the shocks are found to have a significant impact; while a shock in reserve bank foreign exchange asset is found to improve it, the world income shock tends to deteriorate it. In the case of fiscal sector, both the shocks lead to a rise in fiscal deficit due to reduction in both nominal and real output.


Appraising the impact of shocks, whether domestic or external, on the overall macroeconomic performance has received considerable importance in the present globalized world. The reason is due to the fact that as a consequence of these shocks, millions of people will be put under abject poverty and deprivation (Bhattacharya and Kar, 2008). Although research on economic shocks has a long history, a clear-cut definition of a shock is lacking. Informally, a shock may be defined as an unexpected disturbance which is exogenous to the economy with significant impact. Shocks can be positive or negative in nature in terms of their impact, but the term is largely associated with those having adverse impact.