Abstract
Using West African Economic and Monetary Union (WAEMU) dataset for 1970 to 2013, and Pesaran et al. (2001) methodology, this study examines the effect of budget deficit and money supply on inflation. Evidence shows that there is a long run relation among the variables in all countries except Mali. Price and budget deficit are positively related in Niger and Togo, and negatively related in Benin and Senegal. Further, money supply and price are positively related in Burkina Faso, Cote d’Ivoire and Senegal. Results from the Granger causality tests indicate that deficits cause money growth in Cote d’Ivoire, Mali and Togo, and cause the price level in Senegal. There is no causality from money supply to inflation in the short-run. Results suggest that idea that budget deficits are not inflationary in WAEMU countries. Hence, the policy of reducing inflation should focus on other macroeconomic and structural determinants of inflation across WAEMU.
Highlights
Inflation is an undesirable factor due to its adverse effects on consumption, investment and economic growth
This study has investigated the causal relationship between budget deficit, money supply and price dynamics in the member countries of the West African Economic and Monetary Union
The empirical evidence reveals a positive relationship between price levels and budget deficits in Niger and Togo, implying that an increase in budget deficit lead to an increase in prices
Summary
Inflation is an undesirable factor due to its adverse effects on consumption, investment and economic growth. The Ricardian equivalence proposition contends that increases in budget deficits do not alter aggregate demand, interest rates and the price level because economic agents anticipate that current tax cuts by the government will be financed by future tax hikes (Barro, 1989) Contrary to these views, the fiscal theory of price level contends that inflation rate is dependent upon the coordination between monetary and fiscal authorities. This study seeks to fill the gap by addressing the following questions: what are the impacts of budget deficits and money supply on the price levels in WAEMU countries? We find that in the short run budget deficits cause money growth in Cote d’Ivoire, Mali and Togo, and prices in Senegal These findings suggest that deficits are not inflationary in the WAEMU member countries.
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