The Relationship Between Budget Deficits & Inflation: Empirical Evidence From African Countries

Abstract

This study aims to reveal the relationship between budget deficits and inflation in African countries in the period of 2001 to 2020. The study utilizes Pooled Mean Group Autoregressive Disturbed Lag (PMG, ARDL) model. It is found that budget deficits have a long-run positive and statistically significant influence on the inflation rate, which emphasizes its role in deciding the price level. Similar findings are revealed for the relationship between budget deficit and labor force in the long run. Meanwhile, broad money growth findings showed both short-run and long-run impacts on the inflation rate. The empirical findings support the existence of Fiscal Theory of Price Level (FTPL) hypothesis in African context. This study offers a novel theory on the relationship between budget deficits and inflation in Africa which is characterized by a persistent inflation rate. The result supports that fiscal and monetary policy are interdependent.