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Budget deficits and inflation feedback

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  • PEKARSKI, Sergei

Abstract

This paper contributes to the literature on budget deficits and inflation in high inflation economies. The main finding is that recurrent outbursts of extreme inflation in these economies can be explained by a certain hysteresis effect associated with public finance. This interpretation meets the evidence that dramatic shifts between regimes of moderately high and extremely high (hyper-) inflation often occur without visible deterioration in public finance or abrupt shifts in fiscal or monetary policies. The existence of this hysteresis effect is explicitly explained by the action of two mechanisms: the arithmetic associated with the wrong side of the inflation tax Laffer curve and the Patinkin effect (the reverse of the much oftener cited Olivera-Tanzi effect). It is also shown that the division of the operational budget deficit into the part that is subject to negative inflation feedback and the part that is inflation-proof, has implications for both the discussion of the inflationary consequences of budget deficits and the proper design of stabilization policy.

Suggested Citation

  • PEKARSKI, Sergei, 2008. "Budget deficits and inflation feedback," LIDAM Discussion Papers CORE 2008054, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2008054
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    File URL: https://sites.uclouvain.be/core/publications/coredp/coredp2008.html
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    References listed on IDEAS

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    1. Albert Marcet & Juan Pablo Nicolini, 2005. "Money and Prices in Models of Bounded Rationality in High Inflation Economies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 452-479, April.
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    Cited by:

    1. Olusola Oyeleke & Monica Orisadare, 2018. "Relative Importance of Public Debts and Money Growth on Inflation in Nigeria," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 10(7), pages 1-99, July.
    2. Bilal Raza & Khurram S Mughal, 2022. "Fiscal Determinants of Inflation in Pakistan," SBP Working Paper Series 108, State Bank of Pakistan, Research Department.
    3. Hanana Khan & Maran Marimuthu & Fong-Woon Lai, 2020. "Fiscal Deficit and Its Less Inflationary Sources of Borrowing with the Moderating Role of Political Instability: Evidence from Malaysia," Sustainability, MDPI, vol. 12(1), pages 1-16, January.
    4. Jalil, Abdul & Tariq, Rabbia & Bibi, Nazia, 2014. "Fiscal deficit and inflation: New evidences from Pakistan using a bounds testing approach," Economic Modelling, Elsevier, vol. 37(C), pages 120-126.
    5. Sokolova, Anna, 2015. "Fiscal limits and monetary policy: default vs. inflation," Economic Modelling, Elsevier, vol. 48(C), pages 189-198.
    6. Lim Chia Yien & Hussin Abdullah & Muhammad Azam, 2017. "Granger Causality Analysis between Inflation, Debt and Exchange Rate: Evidence from Malaysia," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 7(1), pages 189-196, January.
    7. Seghezza, Elena, 2022. "The Cagan's Model, its Developments, and the Patinkin Effect," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 75(4), pages 601-622.
    8. Magazzino, Cosimo, 2011. "The nexus between public expenditure and inflation in the Mediterranean countries," MPRA Paper 28493, University Library of Munich, Germany.

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    More about this item

    Keywords

    budget deficit; high inflation; the Patinkin effect.;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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