INFLATION--DEFICIT--MONEY-SUPPLY NEXUS IN AN OPEN ECONOMY WITH RATIONAL EXPECTATIONS: AN EMPIRICAL APPROACH (MONETARY, MACRO, ARGENTINA)

One guiding principle of this paper has been to synthesize a number of macroeconomic issues--an endogenous government deficit and money supply, and the latter's impact on inflation and balance of payments under the assumption of "rational" expectations--in a monetary framework and understand the interactions among them. The other has been to address econometric issues raised by the "rationality" of forward expectations. In an application to Argentina's experience with rampant inflation in 1970s, limited information estimators are employed, and use of a relatively new and efficient estimator, 2S-2SLS, is investigated.; The model focuses on (i) the endogenous forces that cause monetary imbalance, and on (ii) balance of payments, and domestic inflation's short-run deviation from the long-run course in a 2-good world--traded and non-traded. Fiscal deficit emerges because lag in collection of revenues is larger than lag in execution of expenditures; furthermore, expenditure elasticity is higher than tax elasticity with respect to income. The consequent deficit is monetized. For money demand, "rational" expectations are assumed. Here inflation feeds on itself while external sector provides an outlet for domestic imbalances.; Some interesting estimation issues are raised by non-observability of forward expectation terms in addition to those raised by assumption of "rationality". McCallum's limited information technique is employed to obtain consistent estimates. Here, the dilemma between correction for inefficiency, and desirability of consistency is resolved by application of 2S-2SLS.; 1970s' Argentina which saw an uncontrollable government deficit, high inflation and a weak external balance--an economic climate with its roots in monetary and fiscal imbalances--provides a good historical sample for an empirical application of the model. Estimates of the structural parameters are similar to those obtained from previous independent studies and corroborate the proposed hypotheses.; Dynamic simulation of the model shows that it captures historical phenomena fairly well. Dynamic stability of the model is put to test by studying the impact of an external shock--a short-lived jump in international inflation, like an oil price shock. The dampening of deviations of each of the endogenous series from "benchmark" paths indicates a dynamically stable model.