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Fiscal Deficits and Inflation: A New Look at the Emerging Market Evidence

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Author Info
Luis Catão
Marco Terrones

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Abstract

Empirical studies have had little success in finding a statistically significant relationship between fiscal deficits and inflation in broad cross-country panels. This paper provides new econometric estimates for a panel of 23 emerging market countries during 1970-2000. Unlike previous studies, we allow for a rich dynamic specification and focus on the long-run relationship between the two variables controlling for differences in the inflation tax base. We find that a 1 percentage point reduction in the ratio of fiscal deficit to GDP typically lowers long-run inflation by 1½ to 6 percentage points, depending on the size of the inflation tax base.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/74.

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Length: 31 pages
Date of creation: 22 Jun 2001
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Handle: RePEc:imf:imfwpa:01/74

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Related research
Keywords: Fiscal policy ; Budget deficits ; Inflation ; Emerging markets ;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Thomas J. Sargent, 1982. "The Ends of Four Big Inflations," NBER Chapters, in: Inflation: Causes and Effects, pages 41-98 National Bureau of Economic Research, Inc. [Downloadable!]
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  3. Dornbusch, Rudiger & Fischer, Stanley, 1993. "Moderate Inflation," World Bank Economic Review, Oxford University Press, vol. 7(1), pages 1-44, January.
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  4. King, Robert G. & Plosser, Charles I., 1985. "Money, deficits, and inflation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 147-195, January. [Downloadable!] (restricted)
  5. Metin, Kivilcim, 1998. "The Relationship between Inflation and the Budget Deficit in Turkey," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(4), pages 412-22, October.
  6. Pesaran, M.H. & Shin, Y., 1995. "An Autoregressive Distributed Lag Modelling Approach to Cointegration Analysis," Cambridge Working Papers in Economics 9514, Faculty of Economics, University of Cambridge.
  7. Marta Campillo & Jeffrey A. Miron, 1996. "Why Does Inflation Differ Across Countries?," NBER Working Papers 5540, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  9. Pesaran, M. H. & Shin, Y. & Smith, R. P., 1997. "Pooled Estimation of Long-run Relationships in Dynamic Heterogeneous Panels," Cambridge Working Papers in Economics 9721, Faculty of Economics, University of Cambridge.
  10. Pesaran, M.H., 1996. "The Role of Economic Theory in Modelling the Long Run," Cambridge Working Papers in Economics 9612, Faculty of Economics, University of Cambridge.
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  11. Marta Campillo & Jeffrey A. Miron, 1997. "Why Does Inflation Differ across Countries?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 335-362 National Bureau of Economic Research, Inc. [Downloadable!]
  12. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May. [Downloadable!] (restricted)
  13. Stanley Fischer & David William Harold Orsmond, 2000. "Israeli Inflation from an International Perspective," IMF Working Papers 00/178, International Monetary Fund.
  14. Haan, Jakob de & Kooi, Willem J., 2000. "Does central bank independence really matter?: New evidence for developing countries using a new indicator," Journal of Banking & Finance, Elsevier, vol. 24(4), pages 643-664, April. [Downloadable!] (restricted)
  15. Dani Rodrik, 1998. "Why Do More Open Economies Have Bigger Governments?," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 997-1032, October. [Downloadable!] (restricted)
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  16. Atish R. Ghosh & Anne Marie Gulde & Jonathan David Ostry & Holger C. Wolf, 1995. "Does the Nominal Exchange Rate Regime Matter?," IMF Working Papers 95/121, International Monetary Fund.
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  17. Prakash Loungani & Phillip Swagel, 2001. "Sources of Inflation in Developing Countries," IMF Working Papers 01/198, International Monetary Fund. [Downloadable!]
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Cited by:
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  1. Philipp C. Rother, 2004. "Fiscal policy and inflation volatility," Working Paper Series 317, European Central Bank. [Downloadable!]
  2. Jeannine Bailliu & Daniel Garcés & Mark Kruger & Miguel Messmacher, 2003. "Explaining and Forecasting Inflation in Emerging Markets: The Case of Mexico," Working Papers 03-17, Bank of Canada. [Downloadable!]
  3. Jérôme Henry & Pablo Hernández de Cos & Sandro Momigliano, 2004. "The short-term impact of government budgets on prices: evidence from macroeconomic models," Working Paper Series 396, European Central Bank. [Downloadable!]
  4. Haider, Adnan & Khan, Safdar Ullah, 2007. "Does Volatility in Government Borrowing Leads to Higher Inflation? Evidence from Pakistan," MPRA Paper 17008, University Library of Munich, Germany. [Downloadable!]
  5. jerome henry & sandro momigliano & pablo hernandez de cos, 2005. "The short-term impact of government budgets on prices Evidence from macroeconometric models," Macroeconomics 0501020, EconWPA. [Downloadable!]
    Other versions:
  6. Domac, Ilker, 2004. "Explaining and forecasting inflation in Tukey," Policy Research Working Paper Series 3287, The World Bank. [Downloadable!]
  7. Ilker Domac, 2003. "Explaining and Forecasting Inflation in Turkey," Working Papers 0306, Research and Monetary Policy Department, Central Bank of the Republic of Turkey. [Downloadable!]
  8. Tahsin Saadi-Sedik & Jean-Louis Combes, 2006. "How Does Trade Openness Influence Budget Deficits in Developing Countries?," IMF Working Papers 06/3, International Monetary Fund. [Downloadable!]
    Other versions:
  9. Ilker Domac & Eray M. Yucel, 2003. "What Triggers Inflation in Emerging Market Economies?," Working Papers 0307, Research and Monetary Policy Department, Central Bank of the Republic of Turkey. [Downloadable!]
    Other versions:
  10. Raghbendra Jha, 2007. "Fiscal Policy in Developing Countries: A Synoptic View," ASARC Working Papers 2007-01, Australian National University, Australia South Asia Research Centre. [Downloadable!]
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