The Lack of Fiscal Consolidation in an Inflationary Economy: Uruguay 1970-2006

44 Pages Posted: 14 Feb 2012

See all articles by Leonardo Vicente

Leonardo Vicente

affiliation not provided to SSRN

Gerardo Marcelo Licandro Ferrando

Central Bank of Uruguay

Date Written: March 29, 2007

Abstract

Different from the papers presented in this session, this one analyzes the lack of fiscal consolidation within a framework of tensions between the objectives of consolidation and price stability. By using a model of time inconsistency with fiscal objectives and a Government’s budget constraint similar to the Uruguayan one, it is shown that the existence of nominal debt in domestic currency and the possibility of reducing real expenditure generate incentives in addition to seignorage for the fiscal use of inflation, avoiding a more lasting consolidation process. By analyzing Uruguayan data between 1970 and 2006 it is evidenced how the real adjustment of Primary Expenditure through inflation has been the key in the fiscal stabilization episodes of the past 35 years. Through the analysis of episodes, correlations and OLS regressions, it is shown that inflation acceleration has played a major role in improving the fiscal balance owing to its effect on real expenditure. Nonetheless, such improvements have been transitory, while real expenditure has bounced back once the adjustment phase was over. This paper offers an institutional reading, since it suggests that the setting of inflation objectives by the Government together with a bias against fiscal consolidation may result in a relative high inflation level.

Keywords: time inconsistency, fiscal uses of inflation, fiscal consolidation

JEL Classification: E52, E58

Suggested Citation

Vicente, Leonardo and Licandro Ferrando, Gerardo Marcelo, The Lack of Fiscal Consolidation in an Inflationary Economy: Uruguay 1970-2006 (March 29, 2007). Available at SSRN: https://ssrn.com/abstract=2004369 or http://dx.doi.org/10.2139/ssrn.2004369

Leonardo Vicente (Contact Author)

affiliation not provided to SSRN ( email )

Gerardo Marcelo Licandro Ferrando

Central Bank of Uruguay ( email )

Diagonal Fabini 777
Montevideo, CP 11100
Uruguay

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