Abstract
Economists generally accept the proposition that high and volatile inflation rates generate inefficiencies that reduce society?s welfare. Furthermore studies have shown that inflation is harmful to economic growth. However determining the causes of the worldwide diversity of inflationary experiences is an important challenge not yet satisfactorily confronted by the profession. Based on a broad dataset covering over 100 countries for the period 1975-1997 and using dynamic and static panel data econometric techniques, this paper shows that a higher degree of political instability is associated with both higher inflation levels and volatility. Not only does this paper advance the political economy literature establishing a relationship between inflation moments and political instability, but it also has important policy implications regarding the optimal design of inflation stabilization programs and of the institutions favorable to price stability.
Highlights
It is generally recognized that high and volatile inflation rates generate inefficiencies that reduce society’s welfare.1 Given the costs associated with high inflation it may seem odd that so many countries have experienced it
Several political economy models rely on the characteristics of the political systems and institutions to explain the diversity of macroeconomic policies adopted and, the diversity of inflation rates observed
Concerning structural variables, the value-added of the agricultural sector as a percentage of GDP (Agric_va) has the expected sign but is weakly statistically significant only in the estimation of column 4, and foreign trade as a percentage of GDP (Trade) has a positive coefficient, indicating that greater openness to trade leads to higher inflation
Summary
It is generally recognized that high and volatile inflation rates generate inefficiencies that reduce society’s welfare. Given the costs associated with high inflation it may seem odd that so many countries have experienced it. It is generally recognized that high and volatile inflation rates generate inefficiencies that reduce society’s welfare.. Given the costs associated with high inflation it may seem odd that so many countries have experienced it. The great diversity of inflationary processes across countries is a puzzling phenomenon. One possible explanation relies on different characteristics of the tax systems resulting from unequal levels of development and/or economic structures. Countries with inefficient tax systems have to resort more frequently to seigniorage revenues, increasing inflation. Several political economy models rely on the characteristics of the political systems and institutions to explain the diversity of macroeconomic policies adopted and, the diversity of inflation rates observed. Suboptimal policies leading to high inflation could result from political instability, polarization or weak institutions
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