The extensive analysis

are plotted on the lower part of Figure 3.¹³ (As inflation, money growth is also transformed into a logarithmic form (log(1+money growth)).) From quantile 0.1 to 0.9, the summations of coefficients of the deficit-to-GDP ratios are 0.1147, 0.1473, 0.1545, 0.1829, 0.1885, 0.2104, 0.2170, 0.2208 and 0.2416. They are significant at the 1% level at quantiles 0.1–0.8 and significant at the 5% level at quantile 0.9.

Although the deficit-to-money ratio is insignificant at quantile 0.1, the summation of coefficients of deficit-to-GDP ratios still becomes larger as the quantile goes higher.

Therefore, when standard specifications (deficit-to-GDP ratio) are estimated, the money growth rates should be controlled. The D-GMM L and D-GMM D estimators are 0.5190 and 0.5372 respectively, and both are significant at the 1% level. These two estimators also support that fiscal deficit is inflationary.

In summary, the dynamic panel results over 1960–2006 show that as inflation rises, the fiscal deficits will be more inflationary, and fiscal deficits will play a weak or non-existing role in inflation when inflation is at a low level. Whether I scale deficits by money, or scale deficits by GDP and control money growth, the results will not change. Therefore, we can know that fiscal consolidation would become more effective in price stabilization as inflation rises.

4.3.2 The extensive analysis

For testing if the deficit-inflation relationship is suitably stable, other possible ex-planatory variables are taken into consideration in equation (16). If the deficit-inflation relationship is sufficiently robust, it should not change after controlling for other explanatory variables. Then, the empirical model would be

π_it= η_i+ α(τ )π_it−1+

p

X

j=0

x⁰_it−jβ_j(τ ) + w⁰_itγ(τ ) + ε_it(τ ), (17)

where w_it is a set of exogenous controlled variables excluding deficits, and γ(τ ) is its parameter to be estimated. Other notations are defined above.

13Corresponding to fiscal deficits, money growth is also lagged three periods.

‧

Other exogenous variables are the growth rate of real GDP per capita, oil price inflation, openness and the exchange rate regime. The growth rate of real GDP per capita is the annual change in real GDP per capita, and oil price inflation is the annual change in the average crude price of petroleum in local currency. Because these two variables are both covering the annual change rate, they are transformed into a logarithmic form (log(1+growth) and log(1+oil price inflation)) as inflation.

Openness is defined as an average of the import- and export-to-GDP ratio, and the exchange rate regime is represented by a de facto index of Reinhart and Rogoff (2004).¹⁴

First, the growth rate of real GDP per capita is considered as a controlled variable in equation (17), and the results are reported in Table 10 and the estimates of fiscal deficits are plotted on the upper part of Figure 4. The meanings of the black solid and the black dotted line are estimates of quantile regression and its 95% confidence interval, and the gray solid and the gray dotted line indicate coefficients of D-GMM L and D-GMM D. The deficit-inflation relationship does not change after controlling the growth. From quantile 0.1 to 0.9, the coefficients are 0.0101, 0.0153, 0.0227, 0.0262, 0.0294, 0.0353, 0.0429, 0.0635 and 0.1120. They are insignificant at quantile 0.1, significant at the 5% level at 0.2, and significant at quantiles 0.3–0.9. Fiscal deficit is still more inflationary as the quantile is higher.

On the other hand, the coefficients of growth are 0.0795, 0.1028, 0.1065, -0.1286, -0.1560, -0.1982, -0.2430, -0.3062 and -0.5654 from quantiles 0.1 to 0.9, and they are insignificant at quantile 0.1 and significant at the 1% level at quantiles 0.2–

0.9. The D-GMM L and D-GMM D estimators are -0.4001 and -0.2630, and both are significant at the 1% level. For this reason, growth is negatively related to inflation, and the higher the inflation rate the stronger the relationship. It means that inflation decline with growth in real GDP per capita, and the higher the inflation the more

14All variables are stationary over 1960–2006, and the t-statistic of the Levin-Lin-Chu test (one lag) for the growth rate of real GDP per capita, oil price inflation and openness are -41.73, -42.71, and -13.73 respectively.

‧

Second, oil price inflation is also a well-known inflationary factor. Theoretically, Ball and Mankiw (1995) proposed a model to describe supply-side shocks, such as an increase in the relative price of oil, could affect the aggregate price level.

Consequently, the movement of the oil price is considered as a controlled variable in several empirical research studies on inflation (Longani and Swagel, 2001; Cat˜ao and Terrones, 2005).¹⁵

The results of controlling growth of GDP per capita and oil price inflation are shown in Table 11 and the estimates of fiscal deficits are plotted on the lower part of Figure 4. The summations of the coefficients of deficit-to-money ratios are 0.0108, 0.0223, 0.0251, 0.0288, 0.0329, 0.0380, 0.0489, 0.0651 and 0.0793 from quantiles 0.1 to 0.9. They are insignificant at quantile 0.1, and significant at the 1% level at quantiles 0.2–0.9. Accordingly, the results of deficits do not change, and the deficits still tend to be inflationary as inflation goes higher. Next, from quantile 0.1 to 0.9, the coefficients of oil price inflation are 0.0481, 0.0391, 0.0449, 0.0595, 0.0739, 0.1010, 0.1319, 0.1875 and 0.3059. They are all significant at the 1% level. Thus, the oil price shock is actually an inflationary factor, and the higher the inflation rates the more associated they are with oil price shock.

Third, trade openness is taken as an explanatory variable. Romer (1993) argued that trade openness could lower the time-inconsistent problem of the monetary pol-icy, so trade openness should be negatively associated with inflation. Empirically, many research studies have supported that the openness-inflation relationship is negative (Romer, 1993; Lane, 1997; Alfaro, 2005). Investigating the deficit-inflation relationship, Cat˜ao and Terrones (2005) also considered openness as a controlled variable.

15Longani and Swagel (2001) measured the average oil prices in dollars, so the oil price is the same for each country in their estimation. I consider that measurement in the local currency is more reasonable, because each country can face various energy prices. Nevertheless, whether measuring in dollars or local currency, the results would not change a lot.

‧

Taking growth of GDP per capita, oil price inflation and trade openness in equation (17), the results in Table 12 show that the coefficients of openness a little vary among estimators of GMM L, GMM D and quantile regression. The D-GMM L coefficient is -0.0791 and significant at the 1% level, but the D-D-GMM D coefficient is -0.0157 and insignificant. On the other hand, the estimates of quantile regression are 0.0042, -0.0030, -0.0070, -0.0100, -0.0118, -0.0162, -0.0174, -0.0148 and -0.0188, but all are insignificant. Although these three estimators are in line with the predicted sign, only the D-GMM L estimator is significant. Therefore, there are some areas of evidence which support that openness could reduce inflation, but it is not as robust.

On the other hand, Table 12 and the upper part of Figure 5 show that the results of deficits are stable. From quantiles 0.1 to 0.9, the summations of the coefficients of the deficit-to-money ratios are 0.0166, 0.0213, 0.0243, 0.0286, 0.0317, 0.0379, 0.0484, 0.0638 and 0.0780. They are significant at the 5% level at quantile 0.1, and significant at the 1% level at quantiles 0.2–0.9. There is a little difference with the above results, which show that the fiscal deficit is insignificant at quantile 0.1, but the fiscal deficit is significant at the 5% level after considering for openness. However, the summation of the coefficient is small and the value is near the results above.

In addition, the summation of the coefficients still becomes larger as quantile grows higher, and it represents that fiscal deficits tend to lead to inflation when inflation is higher. It is still consistent with the above results.

Finally, the exchange rate regime is also a possible factor related to inflation.

Conventional wisdom suggests that the fixed exchange rate regime could provide more monetary discipline, because policy makers have incentives to control the money supply or implement a stable monetary policy. Historically, many coun-tries have used a fixed exchange rate as a nominal anchor for lowering inflation (Calvo and V´egh, 1999). I use the exchange rate regime index of Reinhart and Rogoff (2004) as an explanatory variable.¹⁶ Ranging from 0 to 6, the smaller the

16Reinhart and Rogoff (2004) classified the exchange regime according to data on

market-‧

dummy the more fixed the exchange rate. In addition, the index is not available for a full sample, so the number of countries drops to 81 (see Appendix D).

After considering the growth of GDP per capita, oil price inflation, trade open-ness and the exchange rate regime, the estimated outcome is shown in Table 13 and the estimates of fiscal deficits are plotted on the lower part of Figure 5. We can see that the coefficients of the exchange rate regime are 0.0050, 0.0075, 0.0088, 0.0098, 0.0116, 0.0148, 0.0171, 0.0203 and 0.0248 from quantiles 0.1 to 0.9, and all are significant at the 1% level. Moreover, the D-GMM L and D-GMM D coefficients are 0.0157 and 0.0101 respectively, and both are significant at the 1% level. Hence, the estimated results support the conventional wisdom that the fixed exchange rate could reduce inflation, and the higher the inflation rate, the more correlated they are to the exchange rate regime.

On the other hand, the summations of the coefficients of deficit-to-money ratios are 0.0168, 0.0229, 0.0306, 0.0321, 0.0355, 0.0382, 0.0437, 0.0539 and 0.0693 from quantile 0.1 to 0.9. They are significant at the 5% level at quantile 0.1 and 0.2, and significant at the 1% level from quantile 0.3 to 0.9. The D-GMM L and D-GMM D coefficients are 0.0398 and 0.0826 at the 1% level of significance. The higher the inflation, the more correlated they are with fiscal deficits. Therefore, the results of fiscal deficit do not change after other explanatory variables are controlled.

Therefore, controlling for other possible inflation-related factors (growth of real GDP per capita, oil price inflation, openness and exchange rate regime) will not change the estimated deficit-inflation relationship. The dynamic panel results are stable and show that as inflation goes higher, inflation will be more associated with fiscal deficits. When inflation is at a low level, fiscal deficit is weakly associated or not related to inflation. Correspondingly, fiscal consolidation would be more helpful to price stabilization as inflation increases.

determined parallel exchange rates, and their index is the de facto exchange regime classification rather than the official classification.

‧