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.
Catão, Luis and Terrones, Marco E., Fiscal Deficits and Inflation
A New Look at the Emerging Market Evidence (May 2001). IMF Working Paper, Vol. , pp. 1-32, 2001. Available at SSRN: http://ssrn.com/abstract=879583