Inflationary effects of budget deficits: evidence from Zambia (1981-2016)
Date
2019
Authors
Mwanza, Sekai
Journal Title
Journal ISSN
Volume Title
Publisher
University of Zambia
Abstract
Empirical and theoretical literature reveals that inflation is not only a monetary
phenomenon. Budget deficits may be inflationary or not depending on the state of
different transmission mechanisms which include the mode of financing budget
deficits, institutional arrangements, the dominant regime, public indebtedness, the
effect of budget deficits on private investment and aggregate demand, central bank
independence, development of financial markets, public sector wages, exchange rate
pass through and external shocks. With inadequate empirical evidence in Zambia, we
are uncertain of the inflationary effects of budget deficits. The general objective of
this study was to examine the relationship between budget deficits and inflation. The
study specifically intended to determine the impact of budget deficits on inflation
and to verify the causal relationship between the two variables. Using the
Autoregressive distributed lag model for time series data ranging from 1981 to 2016,
the results show that there is a significant positive relationship between budget
deficits and inflation. The results also reveal that there is incomplete pass-through
from budget deficits to inflation. The mean average lag time for complete adjustment
to equilibrium after a shock is approximately 10.7 months. Results of the error
correction based granger causality test show evidence of a unidirectional causality
from budget deficits to inflation both in the shortrun and longrun. The results clearly
indicate that a policy package that lowers budget deficits to sustainable levels would
lower the inflation rate. Therefore, there is need for enhanced coordination between
monetary and fiscal policy in Zambia. It is found that inflationary effects of budget
deficits in Zambia are characterized by the Quantity Theory of Money and the Fiscal
Theory of the price level. These theories may play an important role in the modelling
and forecasting of inflation in Zambia.
Key Words: Budget Deficits, Inflation, Granger Causality, Error Correction Model,
Autoregressive Distributed Lag Model.
Description
Keywords
Budget Deficits-- Inflation