The Effect of Inflation Uncertainty on Budget Deficit: Evidence from Iran

Abstract

Statistics show that in some countries (generally less developed) with high inflation there exists a large budget deficit. Since the statistical evidence can suggest how inflation and budget deficiency are related, it can be used to find the best monetary policy to obtain a balanced state budget. The main objective of this study is to evaluate the effect of inflation uncertainty on budget deficiency in Iran in the period of 1970-2013. For this purpose, first, using GARCH approach, uncertainty index is modeled and then using ARDL model, the relationship between inflation uncertainty and budget deficiency is investigated. The results show that since an increase in inflation uncertainty reduces government revenues, it leads to budget deficiency. Also, the results from error correction model shows that the error correction coefficient is -0.62 and if the model diverge from its long run equilibrium, 62 percent of the error would disappear in each period.

Keywords: Inflation, Uncertainty, Budget deficit, ARDL approach, GARCH.

JEL Classification: E31, H68, C52, C51