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00/13 Budget deficits, money growth and inflation: The Turkish evidence

Erdal Özmen and Ayca Tekin Koru

This paper investigates the long-run relationships between budget deficits, inflation and monetary growth in Turkey considering two alternative trivariate systems corresponding to the narrowest and the broadest monetary aggregates. While the joint endogeneity of money and inflation rejects the validity of the monetarist view lack of direct relationship between inflation and budget deficits makes the pure fiscal theory explanations illegitimate for the Turkish case. Consistent with the policy regime of financing domestic debt through commercial banking system budget deficits lead to a growth not of currency seigniorage but of broad money. This mode of deficit financing, leading to a creation of near money and restricting the scope for an effective monetary policy, may not be sustainable, as the government securities/braod maoney raito cannot grow without limit.

2000

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