Is Inflation Fiscally Determined?

Bazzaoui, Lamia and Nagayasu, Jun (2019): Is Inflation Fiscally Determined?

Abstract

This paper examines the relationship between fiscal variables and inflation for 46 countries from 1960–2017 using a linear identity that links inflation to fiscal and monetary variables and economic growth. The results indicate that inflation is affected by both monetary and fiscal policies. However, the relation between inflation and fiscal variables disappears when monetary policy is based on commitment strategies. We conclude that fiscal determinacy of inflation is only possible when central banks practice poorly structured discretion.

• Item Type: MPRA Paper
• Language: English
• Keywords: inflation, fiscal policy, monetary policy, public debt, panel VAR GMM
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; H - Public Economics > H6 - National Budget, Deficit, and Debt > H63 - Debt ; Debt Management ; Sovereign Debt

References

Aizenman, J. and Y. Jinjarak (2010). De facto fiscal space and fiscal stimulus: Definition and assessment. Technical report, National Bureau of Economic Research.

Aizenman, J., Y. Jinjarak, H. T. K. Nguyen, and D. Park (2019). Fiscal space and government-spending and tax-rate cyclicality patterns: a cross-country comparison, 1960-2016. Journal of Macroeconomics 60, 229–252.

Anderson, T. W. and C. Hsiao (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics 18(1), 47–82.

Andres, J. and I. Hernando (1997). Inflation and economic growth: some evidence for the OECD countries. Monetary Policy and the Inflation Process-BIS Conference Papers (4), 364–383.

Aratawari, R., T. Hori, and K. Mino (2016). On the nonlinear relationship between inflation and growth: a theoretical exposition. Kyoto University Discussion papers.

Arellano, M. and S. Bond (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies 58(2),277–297.

Arellano, M. and O. Bover (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics 68(1), 29–51.

Auerbach, A. J. and W. G. Gale (2011). Tempting Fate: The Federal Budget Outlook. Brookings Institution Washington, DC.

Bajo-Rubio, O., C. Dıaz-Roldan, and V. Esteve (2009). Deficit sustainability and inflation in EMU: An analysis from the fiscal theory of the price level. Barro, R. J. et al. (1996). Inflation and growth. Review-Federal Reserve Bank of Saint Louis 78, 153–169.

Bassetto, M. and W. Cui (2018). The fiscal theory of the price level in a world of low interest rates. Journal of Economic Dynamics and Control 89, 5–22.

Blundell, R. and S. Bond (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics 87(1), 115–143.

Bohn, H. (1998). The behavior of US public debt and deficits.

Bohn, H. (2008). The sustainability of fiscal policy in the United States. CESifo Working Paper Series: Sustainability of Public Debt (1446), 15–49.

Buiter, W., G. Corsetti, and N. Roubini (1993). Excessive deficits: Sense and nonsense in the treaty of maastricht. Economic Policy 8.

Buiter, W. H. (1985). A guide to public sector debt and deficits. Economic policy 1(1), 13–61.

Calvo, G. A. (1978). On the time consistency of optimal policy in a monetary economy. Econometrica 46(6), 1411–1428.

Canzoneri, M. B., R. E. Cumby, and B. T. Diba (2001). Is the price level determined by the needs of fiscal solvency?

Cato, L. A. and M. E. Terrones (2005). Fiscal deficits and inflation. Journal of Monetary Economics 52(3), 529 – 554.

Cobham, D. (2018). A comprehensive classification of monetary policy frameworks for advanced and emerging economies. MPRA Paper.

Cochrane, J. H. (1999). A Frictionless View of U.S. Inflation. In NBER Macroeconomics Annual 1998, volume 13, NBER Chapters, pp. 323–421.

Cochrane, J. H. (2005). Money as stock.

Cochrane, J. H. (2018). Stepping on a rake: The fiscal theory of monetary policy. European Economic Review 101, 354–375.

Cochrane, J. H. (2019a). The fiscal roots of inflation. Working paper.

Cochrane, J. H. (2019b). The Fiscal Theory of the Price Level. Chicago Booth.

Creel, J. and H. Le Bihan (2006). Using structural balance data to test the fiscal theory of the price level: Some international evidence.

De Gregorio, J. (1992). Economic growth in Latin America. Journal of Development Economics 39(1), 59–84.

Fan, J., P. Minford, and Z. Ou (2013). The fiscal theory of the price level-identification and testing for the UK in the 1970s. Cardiff Economics Working Papers, Cardiff University E2013/12.

Favero, C. A. and T. Monacelli (2005). Fiscal policy rules and regime (in) stability: evidence from the US.

Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics 32(3), 485–512.

Fischer, S., R. Sahay, and C. A. Vegh (2002). Modern hyper-and high inflations.

Ghosh, A. R., J. I. Kim, E. G. Mendoza, J. D. Ostry, and M. S. Qureshi (2013). Fiscal fatigue, fiscal space and debt sustainability in advanced economies. Economic Journal 123(566), F4–F30.

Gomme, P. (1993). Money and growth revisited: Measuring the costs of inflation in an endogenous growth model. Journal of Monetary Economics 32(1), 51–77.

Heller, M. P. S. (2005). Understanding fiscal space. International Monetary Fund.

Holtz-Eakin, D.,W. Newey, and H. S. Rosen (1988). Estimating vector autoregressions with panel data. Econometrica 56(6), 1371–1395.

Kaminsky, G., S. Lizondo, and C. M. Reinhart (1998). Leading indicators of currency crises. IMF Staff Papers 45(1), 1–48.

Koop, G., M. H. Pesaran, and S. M. Potter (1996). Impulse response analysis in nonlinear multivariate models. Journal of Econometrics 74(1), 119–147.

Kormendi, R. and P. Meguire (1985). Macroeconomic determinants of growth: Crosscountry evidence. Journal of Monetary Economics 16(2), 141–163.

Kydland, F. E. and E. C. Prescott (1977). Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy 85(3), 473–491.

Leeper, E. M. (1991, February). Equilibria under 'active’ and 'passive’monetary and fiscal policies. Journal of Monetary Economics 27(1), 129–147.

Loyo, E. (1999). Tight money paradox on the loose: a fiscalist hyperinflation. Mauro, M. P., R. Romeu, M. A. J. Binder, and M. A. Zaman (2013). A Modern History of Fiscal Prudence and Profligacy. Number 13-15. International Monetary Fund.

Nickell, S. (1981). Biases in dynamic models with fixed effects. Econometrica 49(6), 1417–1426.

Ostry, J. D., A. R. Ghosh, J. I. Kim, and M. S. Qureshi (2010). Fiscal space. International Monetary Fund, Research Department.

Pesaran, H. H. and Y. Shin (1998). Generalized impulse response analysis in linear multivariate models. Economics letters 58(1), 17–29.

Reinhart, C. M. and K. S. Rogoff (2009). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press.

Rogoff, K. (1985). The optimal degree of commitment to an intermediate monetary target. The Quarterly Journal of Economics 100(4), 1169–1189.

Sargent, T. and N. Wallace (1981). Some unpleasant monetarist arithmetic. Federal Reserve Bank of Minneapolis Quarterly Review.

Sigmund, M. and R. Ferstl (2017). Panel vector autoregression in R with the package panelvar.

Sims, C. A. (1994). A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy.

Sims, C. A. (2011). Stepping on a rake: The role of fiscal policy in the inflation of the 1970s. European Economic Review 55(1), 48–56.

Stockman, A. C. (1981). Anticipated inflation and the capital stock in a cash in-advance economy. Journal of Monetary Economics 8(3), 387–393.

Tanner, E. and A. M. Ramos (2003). Fiscal sustainability and monetary versus fiscal dominance: evidence from Brazil, 1991–2000.

Vaona, A. (2012). Inflation and growth in the long run: A New Keynesian theory and further semiparametric evidence. Macroeconomic Dynamics 16(1), 94–132.

Woodford, M. (1994). Monetary policy and price level determinacy in a cash-in-advance economy.

Woodford, M. (1995). Price-level determinacy without control of a monetary aggregate. Carnegie-Rochester Conference Series on Public Policy 43, 1–46.