Causality between Public Deficits and Inflation : Some Tests for the Portuguese Case

The empirical research of the relation between deficits and inflation can be conducted through Granger-causality tests. The tests made for Portugal, for the 1979:1 1994:4 period, show some evidence that deficits cause inflation. This is true in a bivariate model and also in a trivariate model which includes the monetary base (or even the money stock measured by M2). The stock of internal direct debt is used to build a proxy for the deficit. There is no evidence that inflation causes the deficits and the same is true for the monetization hypothesis, so that one can assume that the relation between deficits and inflation is probably through aggregate demand