Fiscal Deficits and Inflation, Issues 2003-2065
Macroeconomic theory postulates that fiscal deficits cause inflation. Yet empirical research has had limited success in uncovering this relationship. This paper reexamines the issue in light of broader data and a new modeling approach that incorporates two key features of the theory. Unlike previous studies, we model inflation as nonlinearly related to fiscal deficits through the inflation tax base and estimate this relationship as intrinsically dynamic, using panel techniques that explicitly distinguish between short- and long-run effects of fiscal deficits. Results spanning 107 countries over 1960-2001 show a strong positive association between deficits and inflation among high-inflation and developing country groups, but not among low-inflation advanced economies.
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Advanced Countries Developing average budget balance budget deficits central bank Central Government Deficit Countries Advanced Countries Countries Developing Countries Countries Emerging Markets cross-country dataset Deficit over Ml deficits and inflation Developing Countries Developing Countries Emerging development All Countries Dynamic Panel Estimates EC Coefficient econometric Emerging Markets equation Estimates of Inflation Exchange Rate Regime explanatory variables financial development fiscal balance fiscal deficits fiscal dominance fixed effects estimates fixed exchange rate h-statistic refers Hausman test IMF's Inflation on Central inflation tax base inflation Top 25 level of financial level of inflation long-run homogeneity restriction low inflation countries MG and PMG MG PMG h-stat MG PMG MG Mid 50 Bottom narrow money Observations 3607 Oil Price Inflation p-values p-values in brackets parenthesis and p-values percentage point PMG estimates PMG MG PMG Price Inflation 0.02 ratio regressions risk-free bond seigniorage slope homogeneity restriction statistically significant t-ratios in parenthesis Table theory Top 25 Mid Vegh