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Fiscal Decentralization and Inflation in Central and Eastern Europe

Makreshanska, Suzana and Petrevski, Goran (2015): Fiscal Decentralization and Inflation in Central and Eastern Europe.

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Abstract

Theoretical conceptions offer ambiguous suggestions about the precise sign of the association between decentralization and inflation (positive or negative). Given the different channels in which decentralization affects macroeconomic stability, this relationship becomes a matter of empirical research. This paper provides empirical evidence on the association between decentralization and inflation on a panel of 11 former transition economies from Central and Eastern Europe (CEE) over the 1991-2011 period. The main findings from our empirical study suggest that decentralizing government activities in CEE countries is conducive with lower inflation rates. Also, we show that not only the extent of fiscal decentralization, but the composition of local revenue, too, matters for macroeconomic stability. Finally, we show that the relationship between fiscal decentralization and inflation is non-linear, i.e. initially, decentralization has favourable effects on macroeconomic stability, but above some threshold, these effects disappear. In these regards, the result from our study are consistent with several theoretical explanations: the commitment theory, the theory of continuity, and the theory of collective action.

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