EMPIRICAL ANALYSIS OF INFLATION AND BUDGET DEFICIT IN THE REPUBLIC OF MACEDONIA

Abstract

The link between budget deficit and inflation occupies an important place in the literature of the monetary economy. For a long time economists worry about the consequences of financing the budget deficit by borrowing or by printing money. Budget deficit is likely when general government spending exceeds overall government revenue. A broad theoretical and empirical literature is designed to examine the relationship between inflation and budget deficit. Some of them support the existence of linkage between them, while in some studies it is proved the non-existence of causality between budget deficit and interest. The purpose of this study is to investigate the empirical link between inflation and budget deficit in Macedonia using quarterly data for the period 1993-2015. The source of data is the Central Bank of the Republic of Macedonia and the State Statistical Office of the Republic of Macedonia. In addition to inflation and budget deficit, as the variables included in our model are also the interest rate and the gross domestic product. The methodology used is VECM (Vector Error Correction Methodology), a methodology well-known for macroeconomic analysis. Previously, stationary testing - ADF test for each variable separately, as well as a co-integration analysis using Johansen's technique. Finally, Granger Causality analyzes the short-term causal relationship between the variables included in the model. From the results obtained from the Granger causality test, we conclude that granger causation in the short term has neither the budget deficit on inflation nor the inflation in the budget deficit. As for the impact among other variables, it is seen that interest causes inflation grants, budget deficit causes granger interest, and also inflation causes granger interest. So, mutual discrepancy is seen between the interest rate and the inflation rate, which speaks of a good monetary policy management over this period. Through the Granger test of causality, we notice that only short-term interest rates have an impact on inflation, while public debt and GDP do not have an impact on inflation. So there is unilateral cause. This implies that we cannot say that it is reasonable to conclude that the expansionary fiscal policy affects inflation in the short term.