Fiscal Deficits and Inflation: A New Look At the Emerging Market Evidence

Marco E. Terrones · Luis Catão

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Monetary Policy and Economic Impact Economic and Fiscal Studies Fiscal Policies and Political Economy

Abstract

The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMP policy.Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.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 of23 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 I percentage point reduction in the ratio of fiscal deficit to GOP typically lowers long-run inflation by 1 y, to 6 percentage points, depending on the size of the inflation tax base.

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References

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