Fiscal Deficit And Inflation

The report on “central government and local government budget implementation of 2015 and budget proposal of 2016”,which was published in the first half of 2016,mentioned that China intends to increase the fiscal deficit ratio to 3% in 2016.This arrangement of scheme is designed to boost effective demands,to cope with the pressure of depression,and to ensure stability and growth of national economy.Along with the report,the national CPI rate is reported 1.6 percent year-on-year growth that hits a five-year low since 2010.As to the determinants of the price,monetarism scholars simply attributed monetary inflation as a monetary phenomenon.However,as the development of the fiscal theory on determinants,economists began to pay more attention to the impact of fiscal policy on the determinants,since they think government's fiscal policy is an important factor of the determinants.Therefore,one of the focal purpose of the paper is to find out whether it will lead to a new round of price rising when the deficit ratio increase to 3%.In the light of literatures relating to the relationship between fiscal deficit and inflation,we modified the derivation process of Aviral Kumar Tiwari's(2012)model and construct a theoretical framework between fiscal deficits and inflation.The theoretical framework has been used to analyze the mechanism of how fiscal deficits affect inflation from three aspects,that is,FTPL,net wealth effect and cost effect.After that,we sort out the variation trend of fiscal deficits and time series characteristic of inflation since the Reform and Opening-up.After the comparison between the time series charts,we examined the relationship between fiscal deficits and inflation.Then,we adopt the HP filtering method to decompose fiscal deficits into two types,which are cyclical deficits and the structural one.Besides,we added monetary policy as a variable to construct two sets of VAR model which analyzing the macro data between year 1978 and 2014.This research work explicates the relationship between fiscal deficits and inflation from perspectives of total amount and structure.Then,it comes to our findings,we organized it as follows: first,from the total amount perspective,even it exists a path from fiscal deficits ? money supply ?inflation,there has no Granger Causality relationship between deficit scale and inflation,that means fiscal deficits indirectly leads to inflation.From the structural point of view,the structural deficit is the Granger Causality of inflation,that is,the structural deficit has a certain explanatory effect on inflation.Second,according to the results of the impulse response function,fiscal deficits has a significant positive impact on inflation from the total amount perspective,and the cyclical deficits has a tightening effect on inflation form the structural perspective,in other words,thestructural deficits has significant positive effect on inflation.This finding confirm that the fiscal deficit is an important cause of China's national inflation.At the last part of the paper,we put forward our policy recommendations as follows: firstly,governments should improving the tax structure system to ensure the financial revenue and accumulating the necessary fiscal surplus in case of pay off debts and deal with the possible period of want or need.Secondly,the structure of financial expenditure should be optimized,that can accelerates the reform of the supply side,promotes economic development and stabilizes financial income.Finally,the independence of the central bank should be strengthened that can improves monetary policy execution,coordinates with fiscal policy,that can ultimately achieve the goal of stabilizing the price policy.