When we think about India, however, there is the question of structural transformation of the economy. There was an old Indian macroeconomics which worried about different things. In recent decades, the economy has changed in fundamental ways: the economy has become mostly open, the role of agriculture has subsided, a financial system has come about and private decisions of firms that are shaped by financial markets now dominate fluctuations of investment. On these themes, you may like to see my article New issues in Indian macro policy.
This raises the question: Does structural transformation change the stylised facts of the business cycle? It appears obvious that when we go from an agriculture-dominated economy to one where agriculture is 12% of GDP, the role of monsoon shocks in GDP should fade away, which should matter for the spectral properties of business cycle fluctuations. Other kinds of structural transformation may not change stylised facts too much. As an example, the IT revolution did not change the business cycle facts in the US. In some respects, things could go in reverse. Some researchers have found that going from a closed to a more open economy yields more consumption volatility, not less, which violates the neoclassical prediction that capital account openness enables better risk sharing.
A recent paper explores these questions: Has India emerged? Business cycle stylised facts from a transitioning economy, by Chetan Ghate, Radhika Pandey and Ila Patnaik, Structural Change and Economic Dynamics, volume 24, page 157--172, March 2013.
The findings of this paper are quite fascinating. Prior to 1991, the stylised facts of the Indian business cycle are quite different from those seen for advanced economies. A sharp change is visible after 1991, and the Indian business cycle becomes more like that of advanced economies. But in the post-1991 period, consumption volatility went up in both absolute and relative terms.
Why did these changes take place? The authors explore a few hypotheses. Was India just lucky in the post-1991 period -- with lower volatility of productivity or monsoon shocks? No, that was not the case.
Did India figure out how to do business cycle stabilisation? No.
The three components which seem to have kicked in are: (a) The decline in the share of agriculture; (b) Investment / inventory cycles rooted in the behaviour of private firms and financial markets and (c) Capital account integration. The fading away of agriculture gave a reduction in the volatility of GDP. Investment and output are now positively correlated thanks to the new investment/inventory cycle that is rooted in the private sector. Pro-cyclicality of capital flows helps explain higher consumption volatility.
A great deal of knowledge in Indian economics was rendered obsolete when India changed from being a closed and poor country to being an open and middle-income economy. We now need to construct a new edifice of empirically grounded knowledge that will help us think about where we now are. This paper will be a key component of this reconstruction.