TITLE:
Regime Effects of Fiscal Deficit Financing and Inflation Dynamics in Ghana
AUTHORS:
Victor Osei, E. Olawale Ogunkola
KEYWORDS:
Fiscal Deficit Financing, Inflation Dynamics, Regime Effect, Theory of Fiscal Price Level
JOURNAL NAME:
Theoretical Economics Letters,
Vol.12 No.1,
February
23,
2022
ABSTRACT: Fiscal deficit financing is
confirmed in both theoretical and empirical literature to often lead to
higher-than-expected inflation. The unsustainable regime of fiscal deficit
financing in Ghana over the years had contributed to price instability in Ghana. Previous studies on deficit
financing-inflation nexus in Ghana concentrated completely on linear and symmetric relation while
ignoring the effect of regime of fiscal deficit financing on inflation. This
study investigated the regime of fiscal deficit financing and its effects on
inflation dynamics in Ghana over the 1980-2018 period. The Theory of Fiscal
Price Level (TFPL) was adopted as the theoretical framework for the study. The
TFPL highlighted the macroeconomic consequences of fiscal dominance over
monetary policy actions and how it impacts on price stability due to the
financing of government fiscal deficit in a country. The study employed
Markov-Switching Regime Dynamic Model (MSRDM) to investigate the regime effects
of fiscal deficit financing on inflation. The study revealed the presence of
two fiscal regimes in Ghana and that the regime of fiscal deficit financing
remained persistent over the study period. The paper further found that fiscal
deficit financing had a stronger effect on inflation dynamics in Ghana in the
higher regime of fiscal deficit financing while its impact on inflation in the
lower regime of fiscal deficit financing remained relatively subdued. The paper
recommends that the government of Ghana should adopt fiscal policy actions that
could lead to the achievement and maintenance of fiscal sustainability and
consolidation consistent with a low inflation regime going forward.