Are fiscal deficits inflationary?

Abstract

This paper applies the dynamic panel quantile regression (DPQR) model under the autoregressive distributional lag (ARDL) specification, and examines the deficit–inflation relationship in 91 countries from 1960 to 2006. The DPQR model estimates the impact of deficits on inflation at various inflation levels and allows for a dynamic adjustment with the ARDL specification. The empirical results show that the fiscal deficit has a strong impact on inflation in high-inflation episodes, and has a weak impact in low-inflation episodes. The results imply that fiscal consolidation would be more effective in price stabilization the higher the inflation rate is, and are consistent with the theoretical model of Catão and Terrones (2005).