Budget deficit, inflation and debt sustainability: evidence from Turkey, 1970-2000

Abstract

We investigate the conditions from which inferences can be drawn regarding sustainability of fiscalstance on the one hand, and a long-run relationship between inflation and budget deficits on the other. These issues have assumed even greater importance in the aftermath of the collapse of the 1999 stabilization program in February 2001 that was designed to achieve sustainability in debt dynamics and produce a permanent reduction in inflation rates. The first set of findings indicates nonstationarity in the discounted debt to GNP ratio process during 1970-2000, implying an unsustainable fiscal outlook. The inference does not imply insolvency, but points to the necessity of a policy change towards fiscal austerity. The second set of findings pertaining to the long-run relationship between the inflation rate, budget deficit, and real output growth suggests two important results. The first of these is that the consolidated budget deficit does not have a long-run component unlike the inflation rate, suggesting that changes in the consolidated budget deficit have no permanent effect on the inflation rate. On the other hand, the PSBR does have a long-run component and is cointegrated with the inflation rate, which implies that the PSBR is a better indicator of fiscal deficits in comparison to the consolidated budget deficit.