The impact of the budget deficit on the currency and inflation in the transition economies

This article investigates the causal linkage between budget deficit, monetary mass and inflation in the transition economies. It is focused on the impact of public expenditures growth on money supply growth, and it does not take in account the amount of budget deficit. We test the new hypothesis that inflation is primarily attributable to public finances imbalances. In our model, the money supply growth is function of budget deficit and GDP growth rate; and inflation is a function of money supply growth and budget deficits. We find a positive relationship between monetary financing of government deficits and money base growth in the case of Albania, Bulgaria, and Romania; public finance imbalances are the main cause of money creation and inflation in these countries.