Title: Academy of Economic Studies Doctoral School of Finance and Banking
1Academy of Economic StudiesDoctoral School of
Finance and Banking
- DISSERTATION PAPER
- BUDGET DEFICIT AND INFLATION
- MSc. Student Marius Serban
- Supervisor Prof. Moisa Altar
2Contents
- I. Objective
- II. The Model
- III. Theoretical Considerations
- IV. Econometric Results
- V. Conclusion
3I. OBJECTIVE
- the influence of budget deficit on inflation rate
in Romania - inflation has fiscal roots
- how large are the effects of deficit cuts upon
inflation
4II. THE MODEL
- a simple version of Woodford (2001) model
- households maximize
with the private budget constraint
5first order condition on ct, mt and bt
- market clearing condition
ct gtyt
6 EQUILIBRIUM CONDITIONS
- real interest rate (r) is assumed constant
7II. THEORETICAL CONSIDERATIONSon how fiscal
deficit affects inflation
- MONETARISTIC THEORY
- FISCAL THEORY OF THE PRICE LEVEL
8MONETARISTIC THEORY
- fiscal dominance regime
- seigniorage pull inflation
- money demand equation determines the price level
9FISCAL THEORY OF THE PRICE LEVEL
- developed by Sargent and Wallace (1981), Leeper
(1991), Dupor (1999), Woodford(1994,1995,1996,1998
), Cochrane (2001) - gouvernment budget constraint is the evaluation
equation of the public debt and not a constraint
10comparison with a stock
- Bt ,gt and tt exogenous and have to meet certain
restrictions - gouvernment budget constraint determines the
price level
11IV. ECONOMETRIC RESULTS
- estimation of the gouvernment budget constraint
which is accepted by both theories - special case no new debt is issued
12- starting from 1996 the public debt is relatively
stable due to - - Asias crisis 1997
- - Russias default in 1998
- -debt payments due in 1999 were 1.9 mil.
- -reduced demand on the domestic market
-
13imposing the restriction on the public debt
results
- the left term is real budget deficit (Dt/Pt)
- the right term seigniorage (S)
14- nonlinear effect of budget deficit on inflation
rate - the lower the monetary base the higher the effect
of budget deficit
15DATA
- period 1991-2001
- p - quarterly inflation rate (consumer price
index) - D - quarterly budget deficit (mil.ROL)
- M - end of quarter monetary aggregate M1 (mil.
ROL) - BM - end of quarter money issuance from the
balance sheet of the central bank (mil. ROL)
16testing series stationarity
- cannot reject the null hypothesis
17testing cointegration - Johansen Test
PARAMETER ESTIMATION with M1
- series are cointegrated starting from the last
quarter of 1993
18vector error correction model
19residuals testing
INF Residuals period 1994-2001
INF Residuals period 1996-2001
0.15
0.15
0.10
0.10
0.05
0.05
0.00
0.00
-0.05
-0.05
-0.10
-0.15
-0.10
94
95
96
97
98
99
00
01
1996
1997
1998
1999
2000
2001
20- monetary aggregate M1 is 6 of GDP
- 1procentual point reduction of the share of
budget deficit in GDP results in 8.2 - 8.7
procentual points reduction in annual inflation
rate
- the share of monetary aggregates in GDP is
assumed constant
21ESTIMATION WITH MONETARY BASE
- testing cointegration - Johansen test
series are cointegrated starting from the last
quarter of 1993
22vector error correction model
23residuals testing
INF Residuals period 1994-2001
INF Residuals period 1996-2001
0.15
0.15
0.10
0.10
0.05
0.05
0.00
0.00
-0.05
-0.05
-0.10
-0.15
-0.10
94
95
96
97
98
99
00
01
1996
1997
1998
1999
2000
2001
24 - monetary base is 4 of GDP
- 1 procentual point reduction of the share of
budget deficit in GDP results in 7.7 - 8.5
procentual points reduction of the annual
inflation rate
25- the adjustment term in VEC is 0.85 and 0.88
- quick impact of the deficit upon inflation
- the transmission channel is 2 quarters
- MONETARIST THEORY
- deficit gt excess money supply gt inflation
- monetary policy cannot stimulate economy through
this channel - FISCAL THEORY OF THE PRICE LEVEL
- deficit gt ? aggregate demand gt inflation
- expectations of future deficits
- fiscal authority must commit to definitly cut
deficits
26GRANGER TEST
27- COMPARISON WITH OTHER STUDIES
- Catao and Terrones (2001) estimate for 23
emerging countries for period 1970-2000 with
annual data - they found a mean estimator ? equal to 1/3 using
M1 for money supply - 5.5 procentual points cut in inflation when the
deficit in GDP is reduced with 1 procentual point - The difference is explained
- ? is 0.52 because is obtained with quarterly data
- including quasi-fiscal deficit could reduce the
effect of deficit upon inflation
28V. CONCLUSION
- the budget deficit explains is the main cause of
inflation - the low level of monetary base makes the deficit
effect very powerful (an increase with 1
procentuial point of the budget deficit in GDP
raises annual inflation rate with 7.7-8.7
procentual points - the adjustments of inflation to a fiscal shock
takes place in 2 quarters - in the future a stricter fiscal discipline is
required to reduce and maintain a low inflation