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Budget Deficits and Inflation: The Roles of Central Bank Independence and Financial Market Development


  • Bilin Neyapti


This article investigates the relationship between budget deficits and inflation with the view that the nature of this relationship depends on the characteristics of monetary and financial institutions. The main hypothesis is that budget deficits are especially inflationary when both the central bank is not independent and the financial market is not developed enough to contain inflationary expectations. The empirical analysis using a panel data that comprises 54 developed and less developed countries, with one to two decades of observations for each, supports this hypothesis. The findings are also robust to subsets of the sample. (JEL "E58", "H62") Copyright 2003 Western Economic Association International.

Suggested Citation

  • Bilin Neyapti, 2003. "Budget Deficits and Inflation: The Roles of Central Bank Independence and Financial Market Development," Contemporary Economic Policy, Western Economic Association International, vol. 21(4), pages 458-475, October.
  • Handle: RePEc:bla:coecpo:v:21:y:2003:i:4:p:458-475

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    References listed on IDEAS

    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    2. Banaian, King & Burdekin, Richard C K & Willett, Thomas D, 1998. "Reconsidering the Principal Components of Central Bank Independence: The More the Merrier?," Public Choice, Springer, vol. 97(1-2), pages 1-12, October.
    3. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-398, September.
    4. Ali F. Darrat, 1985. "Inflation and Federal Budget Deficits: some Empirical Results," Public Finance Review, , vol. 13(2), pages 206-215, April.
    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 412-422, October.
    6. Alex Cukierman, 1992. "Central Bank Strategy, Credibility, and Independence: Theory and Evidence," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031981, July.
    7. Burdekin, Richard C. K. & Wohar, Mark E., 1990. "Monetary institutions, budget deficits and inflation : Empirical results for eight countries," European Journal of Political Economy, Elsevier, vol. 6(4), pages 531-551.
    8. Cukierman, Alex & Miller, Geoffrey P. & Neyapti, Bilin, 2002. "Central bank reform, liberalization and inflation in transition economies--an international perspective," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 237-264, March.
    9. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-1426, November.
    10. Neyapti, Bilin, 2001. "Central bank independence and economic performance in eastern Europe," Economic Systems, Elsevier, vol. 25(4), pages 381-399, December.
    11. Giannaros, Demetrios S. & Kolluri, Bharat R., 1985. "Deficit spending, money, and inflation: Some international empirical evidence," Journal of Macroeconomics, Elsevier, vol. 7(3), pages 401-417.
    12. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-162, May.
    13. Dwyer, Gerald P, Jr, 1982. "Inflation and Government Deficits," Economic Inquiry, Western Economic Association International, vol. 20(3), pages 315-329, July.
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    Cited by:

    1. Bilin Neyapti & Secil Ozgur, 2007. "The Effects Of Fiscal And Monetary Discipline On Budgetary Outcomes," Contemporary Economic Policy, Western Economic Association International, vol. 25(2), pages 146-155, April.
    2. Jácome, Luis I. & Vázquez, Francisco, 2008. "Is there any link between legal central bank independence and inflation? Evidence from Latin America and the Caribbean," European Journal of Political Economy, Elsevier, vol. 24(4), pages 788-801, December.
    3. Hermann Sintim-Aboagye, 2005. "Emerging Economies, Turnover Rates and Inflation Variability: A Comparison of Generalized Maximum Likelihood and SUR Models," Economic Change and Restructuring, Springer, vol. 38(2), pages 167-178, June.
    4. Cristina Bodea, 2013. "Independent central banks, regime type, and fiscal performance: the case of post-communist countries," Public Choice, Springer, vol. 155(1), pages 81-107, April.
    5. Salahodjaev, Raufhon, 2015. "Does intelligence help fighting inflation: an empirical test?," MPRA Paper 66882, University Library of Munich, Germany.
    6. Hermann Sintim-Aboagye & David Tufte, 2006. "Central Bank Independence, Inflation Variability, and the Revenue Smoothing Hypothesis," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 12(2), pages 147-160, May.
    7. Yaya Keho, 2016. "Budget deficits, money supply and price level in West Africa," Journal of Economic and Financial Studies (JEFS), LAR Center Press, vol. 4(5), pages 1-8, October.
    8. repec:pra:mprapa:61939 is not listed on IDEAS
    9. Hove, Seedwell & Tchana Tchana, Fulbert & Touna Mama, Albert, 2017. "Do monetary, fiscal and financial institutions really matter for inflation targeting in emerging market economies?," Research in International Business and Finance, Elsevier, vol. 39(PA), pages 128-149.
    10. Kamal, Mona, 2010. "الإطار النظرى للتنسيق بين السياستين المالية والنقدية
      [The Theoretical Framework for the Coordination of Fiscal and Monetary Polices]
      ," MPRA Paper 26856, University Library of Munich, Germany.
    11. repec:kap:iaecre:v:12:y:2006:i:2:p:147-160 is not listed on IDEAS
    12. Eric Wang & Eskander Alvi, 2011. "Relative Efficiency of Government Spending and Its Determinants: Evidence from East Asian Countries," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 1(1), pages 3-28, June.

    More about this item

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus


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