Fiscal Deficits and Inflation

33 Pages Posted: 28 Jan 2006

See all articles by Luis Catão

Luis Catão

International Monetary Fund (IMF)

Marco E. Terrones

International Monetary Fund (IMF)

Date Written: April 2003

Abstract

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.

Keywords: Fiscal Policy, Inflation, Macroeconomic Stabilization, Developing Countries

JEL Classification: E31, E60

Suggested Citation

Catão, Luis and Terrones, Marco E., Fiscal Deficits and Inflation (April 2003). IMF Working Paper, Vol. , pp. 1-33, 2003. Available at SSRN: https://ssrn.com/abstract=879140

Luis Catão (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Marco E. Terrones

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-4329 (Phone)

HOME PAGE: http://imf.org/external/np/CV/AuthorCV.aspx?AuthID=171

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