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Is Inflation Fiscally Determined?

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  • Lamia Bazzaoui

Abstract

The aim of the present paper is to study the relationship between fiscal variables and the inflation rate for a sample of countries, over the period 1960-2017, based on a linearized equation derived from a households 'budget constraint. This equation links the inflation rate to both fiscal and monetary policy, in addition to the growth rate. We follow the same approach as Cochrane (2019a) and analyze the impact of shocks to these three variables. Impacts from fiscal and monetary policy to the inflation rate are then decomposed between different monetary policy regimes and fiscal space categories. Results indicate that the short-term interest rate is the most significant determinant of inflation. Fiscal policy also affects the inflation rate negatively through the fiscal balance, but this effect is not robust across all mon- etary policy frameworks (this relation only holds in unstructured or loosely structured discretionary monetary policy regimes). The vari- able of fiscal space on the other hand proves to be an important factor as inflation appears to be more sensitive to both fiscal and monetary policy when fiscal space is limited. Finally, we also find that, as pre- dicted by Sargent & Wallace (1981), fiscal policy can cause inflation only when the growth rate is lower than the interest rate.

Suggested Citation

  • Lamia Bazzaoui, 2019. "Is Inflation Fiscally Determined?," TERG Discussion Papers 411, Graduate School of Economics and Management, Tohoku University.
    • Handle: RePEc:toh:tergaa:411
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    File URL: http://hdl.handle.net/10097/00126163
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