Fiscal Deficits and Inflation

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.Developing countries;Budget deficits;Economic models;inflation, price inflation, monetary policy, inflation tax, low inflation, inflation rates, high inflation, monetary fund, central bank, inflation rate, money stock, lower inflation, inflation performance, monetary economics, money demand, real interest rates, high inflations, real value, monetary expansion, high inflation episodes, moderate inflation, price level, money supply, average inflation, inflation dynamics, inflation data, rate of inflation, money growth, expansionary monetary policy, moderate ? inflation, real interest rate, printing money, extreme inflation, effects of inflation, inflation stabilization, reserve requirements, high-inflation episodes, inflationary pressures, monetary discipline, monetary aggregates