Fiscal Deficits and Inflation: A New Look at the Emerging Market Evidence
IMF Working Papers, May 1, 2001
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Bibliographic details
- Authors: Marco Terrones, Luis Catão
- Published: May 1, 2001
- Series: IMF Working Papers
Summary
- 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.
- The analysis allows for a rich dynamic specification and focuses on the long-run relationship between fiscal deficits and inflation while controlling for differences in the inflation tax base.
- Key quantitative result: 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.
Methodology and Scope
- Sample: panel of 23 emerging market countries.
- Sample period: 1970-2000.
- Econometric approach: rich dynamic specification emphasizing the long-run relationship between fiscal deficits and inflation.
- Controls: differences in the inflation tax base.
Main Findings
- Broad cross-country panels historically showed little statistically significant deficit-inflation relationship; this study identifies a robust long-run link in the specified emerging market panel.
- Magnitude of effect:
- A 1 percentage point reduction in the fiscal deficit-to-GDP ratio → long-run inflation reduction of 1½ to 6 percentage points, conditional on the inflation tax base.
Policy Implications
- Fiscal consolidation that reduces the deficit-to-GDP ratio can have substantial long-run disinflationary effects in emerging market economies.
- The effectiveness of deficit reductions in lowering inflation varies with the size of the inflation tax base; policymakers should account for country-specific inflation tax base characteristics when designing fiscal adjustments.
Content in this bundle
- Fiscal Deficits and Inflation: A New Look at the Emerging Market Evidence - WP/01/74