Budget Deficits, Money Supply and Inflation in Tanzania: A Multivariate Granger Causality Test, 1967–2010

Abstract

This paper investigates empirically the nexus between budget deficits, money supply and inflation in Tanzania by employing data for the period 1967–2010. Pair-wise Granger causality test established a one-way causal effect, running from inflation to budget deficit and the monetary base. These findings were supported by results from the Vector Error correction model (VECM) estimated. It is shown that there exist a significant inflation inertia and causal effect on budget deficit over the short-run. The VECM results showed that shift in monetary policy regime exerted a significant effect on inflation and budget deficits. Innovation of the ratio of budget deficit to money balances as alternatives for the traditional budget deficit to income ratio was found to lack significant effect on the results. Results are very indicative but highlight the importance of containing inflation to check its effect on budget deficits over the short-to long-run periods. The results also suggest that robust econometric results can be obtained by deflating budget deficits by monetary aggregates or income.