Date of Award:

1985

Document Type:

Dissertation

Degree Name:

Doctor of Philosophy (PhD)

Department:

Economics and Finance

Advisor/Chair:

L. Dwight Israelsen

Abstract

The purpose of this study was threefold: (1) to test the existing theory which explains inflation as a result of its self-generating nature; (2) to investigate the contribution of foreign trade upon inflation; and (3) to test the casual relationship between the rate of inflation and the deficit. A system of four equations has been used to explain the relationship between the price level and the monetary expansion, between the rate of growth of the monetary base and the rate of the monetary expansion, the deficit and the monetary base, and, finally, between the deficit and the price level. As the existing model was exposed to open economy assumptions by introducing foreign reserves as another source of variation of monetary base, the explanatory power of the model increased. That is, as the results suggest, explaining the inflation/deficit chain in the context of a closed economy assumption leaves much of the process unexplained. Even though part of the increase in the monetary base is caused by foreign trade, a major portion of the expansion in monetary base is caused by the deficit. That is, a government's expenditure exceeds its revenue in any given year, which results in financing that deficit through borrowing from the central bank--that is, monetizing the deficit.

This study suggests that no generality can be made regarding the source of inflation in Latin America. In some countries, the source of inflation is only the deficit, while in others it is only foreign reserves and deficit contribute to the rate of inflation simultaneously, the effect of foreign reserves is less expansionary. This can be seen from the magnitude of the respective parameter estimates.

In the last part of the study, the Granger test of causality has been used to test the causal relationship between the price level and the deficit. Again, countries exhibit heterogeneous results. In some, inflation apparently causes the deficit, while in others, the deficit is the cause of inflation. In several countries, strong feedback exists between these two variables. As a result, it can be concluded that the extent and sources of inflation for countries under study are different.

In conclusion, a few policies are suggested which could be used to bring both deficits and inflation at least to some acceptable level.

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Economics Commons

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