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Developing countries across the globe have always shared the misfortune of being unable to finance their proposed government expenditures using their public revenues. As a result, a budget deficit is a common feature of all underdeveloped nations, to which Bangladesh is no exception. Conventional economic notion asserts that rising gap between government's expenditure and revenue creates pressure to enhance money supply in the economy which in turn may trigger the domestic rate of inflation. In addition, monetary policy tools are also referred to be ineffective in controlling domestic inflation. Thus, the objective of the paper is to identify the causal relationships between Inflation, money supply and budget deficit in the context of Bangladesh incorporating relevant data from 1980 to 2014. Granger Causality test and Vector Error-Correction Model approach was used to identify the long-run and short-run causalities between the variables. The results coincide with the conventional economic conjecture as a unidirectional causality is found to be running from budget deficit to inflation in the short-run while no causality is found between money supply and inflation in both the short-run and the long-run.
Seminar paper from the year 2016 in the subject Economics - Monetary theory and policy, language: English, abstract: Since the main objective of the paper is to test the existence of causality relationship between the three macroeconomic variables, namely real GDP, price level (CPI) and M2 money supply (MS), analysis has been made there by employing 40 years of data. VAR Granger causality test has been made to verify the objective of the paper. The VAR Granger causality test result suggesting the existence of strong and significant correlation between the three variable s pairwise. The direction of causation is found to be a uni- directional causation between money supply and inflation, real GDP and Money supply and between real GDP and inflation and the causation runs from money supply to inflation, real GDP to Money supply and real GDP to inflation respectively. From the causation we observed that money supply has relationship with level of price and economic growth (real GDP). Basically targeting monetary expansion has a multiple role to boost economic growth and control the level of inflation. Keynesians, monetarists, and new classical economists agree that the steady state rate of inflation is closely related to growth of the money supply, and that monetary policy can not affect the equilibrium rate of unemployment. The best slogan of monetarist school of thought "money matters," they argued that changes in the amount of money in the circulation are the sources of other economic changes. In other words, the changes in the size of money supply have a number of implications on the macroeconomics variables especially inflation. Apart from being a powerful instrument of monetary policy, its expansion or contraction dictates the growth in investment and output of any economy. The supply of money is widely accepted as a key determinant of the levels of output and employment in the short run and the level of prices in the long run.
The paper develops a model of inflationary finance that defines the fiscal deficit as a function of the virtual deficit—a deficit that would be observed if inflation were zero. It studies the negative relationship between the inflation rate and real government expenditures—the Patinkin effect. The model outperforms others in explaining four-digit inflation rates that never explode into hyperinflation. It also explains how apparently expansionist fiscal policies end in real deficits that are small and compatible with the small amount of seigniorage that can be collected at high inflation rates. Finally, it applies the model to the case of Brazil.
This paper investigates the short run as well the long run relationships between money supply, inflation, government expenditure and economic growth by employing the Error Correction Mechanism (ECM) and Johansen co-integration test respectively for the case of Cyprus using annual data from 1980 to 2009. Collectively, empirical results imply that public spending promotes economic development in Cyprus. However, deficit financing by the government causes more liquidity effects but also inflationary pressure in the economy. Results show that inflation negatively effects economic growth probably due to adverse supply shock. Money supply should be allowed to grow according to the real output of the economy but excess growth of money causes inflationary pressure in case of Cyprus. Therefore, this paper suggests that the government should control its current expenditure that stimulates aggregate demand and to focus more on development expenditure which stimulates aggregate supply and increases real output level.
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.
Background: One of the principal goals of monetary policy pursued by Central Banks worldwide is virtually price stability. Understanding inflationary dispositions and its determinants is therefore a critical issue from the monetary authorities, scholars and the policy makers viewpoint. The purpose of this paper is to investigate the budget deficit and inflation nexus for Uganda for the period 1980-2016. This is because budget deficit in Uganda has been one of the top topical issues of concern in the country's historical economic problems. The study employs the cointegration and error correction model (ECM) as well as the pairwise Granger causality. This is because the ECM technique has become a tool of choice for estimation and testing the multivariate relationships among the non-stationary data in much of the time series macro-econometrics.Results: Results of the Granger causality test show that budget deficit Granger causes inflation in Uganda at a conventional level of significance. However, no feedback effect is observed. The cointegration results reveal a positive and statistically significant long-run relationship between the series, and the results of the ECM reveal that budget deficit causes inflation in Uganda only in the short run. Further, in Uganda, budget deficit affects inflation directly and indirectly through fluctuations in the nominal exchange rate and money supply.Conclusions: The main conclusion from this analysis is the existence of the long-run relationship among inflation, budget deficit and money supply. This was thus an indication of Granger causality in at least one direction among the variables. However, the impact of trade balance and exchange rate were taken as exogenous. A long-run stationary relationship between the budget deficit, money supply, inflation, trade balance and the exchange rate has been found to hold for Uganda. The major implications for this study are that inflation in Uganda is caused by both monetary as well as fiscal factors. A comprehensive policy package involving budgetary, monetary as well as exchange rate policies is required to deal with inflation.
This book explores the disastrous economic consequences of pseudo lending for pseudo reforms that occurred when the IMF, as a representative of the West, pretended to aid the transition economy of post-communist Russia through stabilization while the Russian government promised reforms.
The empirical research of the relation between deficits and inflation can be conducted through Granger-causality tests. The tests made for Portugal, for the 1979:1 1994:4 period, show some evidence that deficits cause inflation. This is true in a bivariate model and also in a trivariate model which includes the monetary base (or even the money stock measured by M2). The stock of internal direct debt is used to build a proxy for the deficit. There is no evidence that inflation causes the deficits and the same is true for the monetization hypothesis, so that one can assume that the relation between deficits and inflation is probably through aggregate demand.
A sustained sizeable deficit budget is problematic for Sri Lanka. Since 1980 to 2014, the Sri Lankan government budget deficit averaged 8.75% of GDP, and recorded the highest ratio of 19.2% of GDP in 1980 (Central Bank Annual reports, 1980-2014). This study examines the association with budget deficit and selected macroeconomic variables in Sri Lanka, using annual time series data for post-liberalization period; 1980-2014. The selected explanatory macroeconomic variables are inflation, interest rate, exchange rate, debt, and real GDP growth rate. Specifically, the study seeks to ascertain the relation-ship between selected macroeconomic variables and the budget deficit with a view to making appropriate recommendations to curb its negative effect to economy. The study carried 210 samples, and for examination of long-run relationship ARDL bounds test technique is applied, and short-run dynamic was examined using the ARDL Granger-Causality test. Further, Granger Causality test was carried out to determine the causality between selected variables and budget deficit, whether the impact were uni or bi-directional. The results revealed that there is a long-run relationship between budget deficit, inflation, interest rate, exchange rate, debts and real GDP growth rate in Sri Lanka. Further, in this study uni-directional relationship was confirmed between budget deficit and debts. The budget deficit cause debt. Additionally, a unidirectional relationship was also identified between budget deficit and inflation. The budget deficit cause inflation. Moreover, this study confirmed there were no uni or bi-direction causality between other selected variables; Interest rate, Exchange, Real GDP growth rate and Budget deficit. Furthermore, the findings show that budget deficit has a meaningful effect on inflation, and debts. The paper recommended that the Sri Lankan government should take actions to control inflation to maintain price stability and to minimize the debts because the government is maintaining a sizable deficit budget since 1957. This research contributes to the idea that there are dimensional and dynamic factors involved between budget deficit and macroeconomic variables that require comprehensive knowledge to increase productivity, improve living standards, and ensure stability of the economic system.