Download The Impact of Budget Deficit

The Impact of the Budget Deficit
on Inflation in Ukraine
Research Report
Commissioned by INTAS
May 2001
R. Piontkivsky, A. Bakun, M. Kryshko, and T. Sytnyk
International Centre for Policy Studies
Ukraine, Kyiv 04070, Str. Voloska, 8/5
Tel.: 044/463-4937
Fax: 044/463-5970
1
1.
Introduction............................................................................................... 4
2.
Theoretical Links ...................................................................................... 5
2.1
Aggregate Supply and Aggregate Demand Analysis ....................................... 5
2.2
Sources of Financing and Money Decomposition ............................................ 6
2.2.1
Borrowing From the Central Bank............................................................. 7
2.2.2
Borrowing From the Public ....................................................................... 9
2.2.3
Running Down Foreign Exchange Reserves .......................................... 10
2.2.4
Accumulation of Arrears ......................................................................... 10
2.3
2.3.1
Olivera-Tanzi Effect ................................................................................ 10
2.3.2
Deferred Inflation Effect .......................................................................... 11
2.3.3
New Fiscal Theory of Price Level ........................................................... 11
2.4
3.
Closing Remarks ........................................................................................... 11
Developments ......................................................................................... 13
3.1
Definitions ..................................................................................................... 13
3.2
Dynamics ...................................................................................................... 14
3.3
Financing ...................................................................................................... 15
3.3.1
Direct NBU financing .............................................................................. 16
3.3.2
External Financing .................................................................................. 16
3.3.3
T-bills (OVDP) Financing ........................................................................ 17
3.4
4.
Specific Theoretical Hypotheses ................................................................... 10
Inflation Performance .................................................................................... 18
Empirical Analysis .................................................................................. 21
4.1
Methodology ................................................................................................. 21
4.2
Regression Results ....................................................................................... 22
4.3
Policy Implications......................................................................................... 23
5.
Conclusions ............................................................................................ 24
6.
References .............................................................................................. 25
7.
Appendices ............................................................................................. 26
Appendix 1. Data Used in the Estimation ................................................................ 26
Stationary Series Graphs ................................................................................... 26
Original Series Graphs ....................................................................................... 27
Summary Statistics ............................................................................................ 27
Appendix 2. Augmented Dickey-Fuller Unit Root Tests Results .............................. 28
Appendix 3. Granger Causality Tests...................................................................... 29
2
Appendix 4. VAR Results........................................................................................ 30
Appendix 5. Stability of VAR scheme ..................................................................... 31
Appendix 6 Cross Correlations ............................................................................... 32
Cross Correlation of Inflation and Government Balance ..................................... 32
Correlations for Contemporaneous Values of Variables Examined..................... 32
Appendix 7. Effects of VAR components on Inflation .............................................. 33
Impulse Response Functions ............................................................................. 33
Impulse Response Functions (cumulative effect) ............................................... 34
Variance Decomposition .................................................................................... 35
3
1.
INTRODUCTION
Since becoming an independent state Ukraine has experienced high levels of both inflation
and budget deficit, making itself an interesting case study of the relationship between the two
fundamental indicators.
In early 90-s consumer price inflation reached a 10000% a year, the highest level among
transition economies not at war. Budget deficits exceeded 10% of GDP. As economic policy
become more constructive, the budget deficit level diminished. The rate of inflation declined
even more sharply to moderate levels. This can be clearly seen as a proof of the deficitinduced hyperinflation. The major source of deficit financing had been National bank credits.
However, as government became able to use other sources of financing of a much smaller
deficit, the link and causality between budget deficit and inflation turned to be less evident.
Though it is widely acknowledged that fiscal imbalances were by far a major determinant of
inflation, there exists no comprehensive study of the impact of the budget deficit on inflation
in Ukraine. De Menil (1997) and Banaian et al. (1998) analyzed the issue for the first half of
the 1990s. The main finding was that fiscal deficit did matter, but only to the extent it
contributed to the money growth. As most of the budget imbalance was being monetized
during that period, it is of no surprise that independent influence of the deficit not found.
Later on, as more possibilities emerged to finance the deficit — through newly created T-bills
market or from external sources — the link between deficit, money and inflation seems to
become much more complicated.
The goal of this research is to analyze the dynamics of the Ukrainian budget deficit and
inflation, try to reveal their mutual impacts, and summarize the lessons from the second half
of the 1990s’ experience. The main hypothesis for empirical testing is whether fiscal
imbalance itself helps to explain the inflation dynamics after the hyperinflation period. Based
on the monthly data from 1995 to mid-2000 our major finding in VAR specification is the
implicit conclusion, that fiscal imbalance, apart from other, purely monetary factors, does
play a role in the inflation determination. A monthly 1%GDP decrease in budget deficit, all of
which was previously monetized, subtracts from annual inflation 0.8%. If a non-monetized
part of the deficit is cut, then annual inflation is lowered by 0.4%. Among the monetary
factors, the most inflationary seems to be the monetization of the deficit. The dynamics of the
National Bank’s claims to government (monetization) appear to be more tightly linked to the
inflation than the monetary base and the exchange rate.
The research team of this project consists of Alex Bakun, Maxym Kryshko, Ruslan
Piontkivsky (team leader), and Tetiana Sytnyk.
The remainder of the report is organized as follows. Section 2 presents a theoretical
framework for the analysis. Section 3 describes the historical developments of the budget
balance, sources and costs of its financing, and inflation dynamics. In section 4 we explore the
relationship empirically and discuss some policy implications. Finally, section 5 is a
conclusion.
4
2.
THEORETICAL LINKS
Generally, budget deficit per se does not cause inflationary pressures, but rather affects price
level through the impact on money aggregates and public expectations, which in turn trigger
movements in prices.
Δ Budget Deficit  Δ Monetary Aggregates, Δ Expectations  Inflation
Money supply link of causality rests on Milton Friedman’s famous thesis that “inflation is
always and everywhere a monetary phenomenon”. This thesis means that continuing and
persistent growth of prices is necessarily preceded or accompanied by a sustained increase in
money supply.
The expectations link of causality works through the intertemporal budget constraint, which
implies that a government with a deficit must run, in present value-terms, future budget
surpluses1. One possible way to generate surpluses is to increase the revenues from
seigniorage, so the public might expect future money growth.
2.1
Aggregate Supply and Aggregate Demand Analysis
In the monetarist perspective this link looks as follows (see Figure 1). Suppose, money supply
is continually increasing, whereas, at the outset, economy is in equilibrium (point A) at full
employment and with output at the natural level. If monetary policy is accommodative to
budget deficit, money supply continues to rise for a long time, the aggregate demand schedule
will shift to the right (AD1 => AD2), thereby causing output to increase above natural level
(point A’). However, growing labor demand then pushes wages up, which in turn leads to the
shift in aggregate supply leftwards until it reaches AS2 position (AS1 => AS2). In point B the
economy has returned to the natural level of output, however, at the higher price level (P2
instead of P1).
Figure 1. Aggregate supply and aggregate demand analysis
AS3
Price
Level
P3
P2
P1
AS1
C
B’
B
A’
A
AD3
AD1
Ynat
1
AS2
AD2
Output
See, for instance, Walsh (1998, 138-157).
5
If the money supply keeps on growing the next period, aggregate demand will again shift to
the right (AD2 => AD3). Then after a while, the AS schedule will move to the left up to the
AS3 position. At the same time, the economy has passed the way from point B to point B’,
and then to point C. Output has temporarily increased above the natural level, but eventually
has declined, while the price level has climbed up to the new height (from P2 to P3)2.
Keynesian analysis of the situation predicts the same movements in aggregate demand and
aggregate supply curves. The only difference lies in the timing: monetarists stress that the
reaction of AS would be quick so that output would not remain above its natural level for a
long time, while Keynesians believe this adjustment to be much slower.
Fiscal policy or supply-side shocks per se cannot produce consecutive increases in price level.
If changes in government expenditures are one-shot and not ever-increasing, then such a
policy can generate only a temporary increase in the inflation rate. Moreover, negative
aggregate supply shocks cannot produce continually increasing price levels, provided that
money supply, and thus aggregate demand, remain unchanged. Basically, these negative
supply shocks will bring the economy below the natural level of output and employment and
at a higher price level only temporarily. Soon, however, with labor market adjustment the
process will go backwards, so that the economy will end up sliding along aggregate demand
curve to the initial price level and natural level of output and employment.
Thus, we seem to have established that high inflation can only take place along with a high
growth of money supply.
2.2
Sources of Financing and Money Decomposition
Approaching the first part of the link we try to explain, and ask the question: how it may
happen that budget deficits generate movements in money. If the public sector spends more
than it receives, such a deficit must somehow be financed in order for the government to pay
its bills.
The budget constraint of the government can be expressed as follows3:
DEF  D g  Dg1  P  (G  I g  T )  i  Dg1
(1)
where
D g  Dg1 is the change in government debt between the current and the previous period,
P is the price level, G  I g  government expenditur es,T  taxes, i  Dg1  interest payments
on previously issued debt.
Government debt, in the form of either bonds or credits, can be held by the public (domestic
and foreign) and by the central bank. Let’s assume for the purposes of the present report that
the central bank’s credit to banking system doesn’t alter over time. Then the change in
monetary base (Mh  Mh1 ) equals the change in the stock of government debt held by
central bank ( Dcg  Dcg1 ) plus the change in foreign exchange reserves E  ( Bc*  Bc*1 ) ,
where E stands for the nominal exchange rate, we obtain:
( D g  Dg1 )  (Mh  Mh1 )  ( D pg  D pg1 )  E  ( Bc*  Bc*1 )
(2)
Equation tells us that in essence, there are three ways to cover a budget deficit:
2
We may have the same insight into why growth of money supply drives inflation, if we turn to quantity theory of
money that relates nominal income, velocity of money and the money supply: P  Y  M V where PY stands
for nominal GDP (price level times real GDP), V denotes velocity of money, and M is the stock of money. If we
assume that V and Y changes are relatively small over time, then proportionality between money and prices
implies that persistent growth of money supply leads to a proportional rise in price level, i.e. to inflation.
3
Following Sachs and Larrain (1993).
6
 by “monetization” of the deficit (i.e. by increasing monetary base or by so called
“printing” money);
 by increase in the public’s (foreign and domestic) holdings of debt;
 by running down foreign exchange reserves at the central bank.
According to Ouanes and Thakur (1997), there exist five different ways of financing budget
deficit, closely corresponding to the above version:
(i)
borrowing from the central bank (or “monetization” of the deficit);
(ii)
borrowing from the rest of the banking system;
(iii)
borrowing from the domestic non-bank sector;
(iv)
borrowing from abroad, or running down foreign exchange reserves;
(v)
accumulation of arrears.
2.2.1
Borrowing From the Central Bank
In other words borrowing from the central bank is called “monetizing” the deficit. Because
this method always leads to the growth of monetary base and of money supply, it is often
referred to as just “printing money”. As can readily be seen from equation (2), here increase
in the high-powered money is the source of financing budget deficit.
Monetization occurs (i) when the central bank directly finances budget deficit by lending
funds needed to pay government bills; or (ii) when the central bank purchases government
debt at the time of issuance or later in the course of open market operations.
DEF  ( D g  Dg1 )  (Mh  Mh1 )  ( D pg  D pg1 )  E  ( Bc*  Bc*1 )
If the central bank just lends funds or purchases newly issued government debt, it simply
pushes up the stock of high-powered money. It may also be the case that the government first
borrows from public or from commercial banking system. However, if the central bank then
intervenes and either buys out the debt from the public by means of open market operations or
accommodates additional demand for liquidity from banking system, the equivalent amount
of reserves gets injected into the economy as if the government originally borrowed from the
central bank. In either case budget deficit (DEF) is financed, as can be seen from equation
above, by increases in high-powered money.
Let us now assume that the government for some reasons can borrow only from the central
bank (it has lost the public’s confidence and foreign exchange reserves are near the critical
level). Then our budget deficit financing equation will look like:
DEF  (Mh  Mh1 )  E  ( Bc*  Bc*1 )
(3)
If we follow the assumptions of Sachs and Larrain (1993) that Purchasing Power Parity
(PPP), as well as quantity theory of money hold, then, under a fixed exchange rate regime,
one reaches the following conclusion: even if government tries to borrow from the central
bank, and it starts printing money, the bank in effect is running down already depleted foreign
exchange reserves, because it has to intervene in foreign exchange market to maintain the
fixed exchange rate. This in turn will lead to a reversal of the money supply increase, i.e.
ultimately DEF  E  ( Bc*  Bc*1 ) will hold. Although the money supply seems not to have
grown much, the resulting upward pressure on exchange rate, stemming from persistent need
of financing and entire foreign exchange reserves exhaustion, may end up in currency
devaluation, which would then greatly increase inflation.
Under a floating exchange rate regime the outcome is different. Let’s now distinguish the
nominal (DEF) from real (DEFr) value of budget deficit so that DEF  DEFr  P . We also
assume that the government cannot borrow from public and foreign exchange reserves are
zero. For simplicity of presentation, we may approximate the change in high-powered money
7
by the change in money supply (because we know the rapid change in the former necessarily
causes the change in latter). Consequently, our equation (3) becomes
DEFr  P  M  M 1 or if we rearrange terms DEFr 
M  M 1
.
P
In other words, the real value of the deficit is now equal to the real value of the change in
money supply. The budget deficit in such a situation is said to be financed by collecting
seigniorage. In Dornbusch and Fischer’s words (1998), seigniorage refers to “the
government’s ability to raise revenue through its right to create money”. The amount of
M  M 1
. If we rearrange components
P
M  M 1
in this formula and introduce percentage growth in nominal money supply  
M
M
and real money balances m 
, then we obtain that S    m .
P
seigniorage (S) is then given by the expression: S 
Interestingly, the amount of seigniorage can usefully be decomposed into the “pure
seigniorage” and “inflation tax” part. It can be shown4 that:
P  P1 P1
P  P1
, then we
)( )  m1 . If we denote the inflation rate as  
P1
P
P1

)  m1 . The first term is referred to as “pure seigniorage” and
would have: S  m  (
1
S  m  (
represents the change in real balances. The second term is called “inflation tax” with

(
) being a tax rate and m1 being a tax base.
1
In the words of Dornbusch and Fischer (1998), “inflation acts just like a tax because people
are forced to spend less than their income and pay the difference to the government in
exchange for extra money. The government thus can spend more resources, and the public
less, just as if the government had raised taxes to finance extra spending”. When government
finances a deficit by printing money, there are good reasons to believe that the public seeks to
maintain real balances so as to offset the effects of inflation. The public therefore chooses to
hold more and more nominal money from period to period, so as to keep real balances and
thus purchasing power constant in the long run. If this is the case, then m  0 , i.e. the
government collects no pure seigniorage, but rather finances the budget deficit entirely
through the inflation tax.
Thus, we may conclude that under a pure floating exchange rate regime, budget deficit ends
up in inflation and, as shown above, the size of the deficit and inflation rate are very closely
connected. According to the formula, higher deficits entail higher inflation rates (Sachs and
Larrain, 1993).
In passing we should note the implication that macroeconomic theory derives about financing
a budget deficit through inflation tax: a sustained increase in money growth and in inflation
ultimately leads to a reduction in the real money stock (Dornbusch and Fischer 1998). With
respect to transition economies, the rationale behind such an implication may be that public
S
4
M  M 1
M
M
P  P1
M M
 (  1 )  1  1  m  M 1 (
)
P
P
P1
P1
P
P  P1
 m 
M 1 P  P1
P  P1
P
(
)  m  (
)  ( 1 )  m1
P1
P
P1
P
8
adjusts to the higher inflation by switching from heavily taxed domestic currency to a
different hard and stable currency (e.g. U.S. dollar).
So far we have basically considered the most essential mechanisms of financing a budget
deficit. However, one additional strong statement that seems appropriate and relevant here
should be made. A sustained inflation may stem only from a persistent rather than a
temporary budget deficit that is eventually financed by printing money rather than by
borrowing from public (Mishkin, 2000).
2.2.2
Borrowing From the Public
Borrowing from the public can be exercised either domestically or internationally.
The ultimate domestic purchasers of government debt, as pointed out by Ouanes and Thakur
(1997), could be: (i) non-bank public; or (ii) banks. The essential difference comes from the
likely impact of the operation on money supply and inflation.
 If the government debt is acquired by non-bank domestic public and then the government
immediately spends the proceeds by paying its bills, then monetary base remains
unchanged, there is no influence on money supply and therefore no room for inflation.
Still, borrowing from public by issuing debt might cause certain inconveniences for
policymakers. For example, bond finance of budget deficit may push up interest rates
thereby putting pressure on private sector finance and on economic growth. Additionally,
the cost of borrowing at such high rates surely increases debt service payments thus adding
to future budget expenditures5.
 If banks acquire the government debt, the consequences with respect to monetary base and
money supply may differ. No doubt, government borrowing puts additional pressure on
banks' reserves and banks may demand more liquidity from the central bank. If such an
extra demand for credit from banks is accommodated and the central bank supplies banks
with additional reserves, then in fact monetary base increases, thereby causing a rise in
money supply through deposit multiplication and thus fueling inflation. However, if the
central bank does not accommodate the extra demand, banks will be forced to reduce
credit to the private sector in order to meet the higher demand for government credit by
purchasing debt (Ouanes and Thakur, 1997). This reduction is often referred to as
crowding out of private spending.
The impact of budget deficit on money supply when government borrows from foreign public
crucially depends on the exchange rate regime.
 If the central bank adheres to a fixed exchange regime, then any foreign borrowing must
be sterilized in foreign exchange market so as to maintain the exchange rate at the
prescribed level. But this means that the central bank has to increase the monetary base by
buying up the excess supply of foreign exchange in return for additional reserves that are
injected into the system.
 Yet, when floating exchange rate regime dominates in the economy, external borrowing to
finance budget deficit allows the government to avoid the increase in monetary base and
money supply and thus prevent inflationary developments. Among consequences of such
policy are the appreciation of exchange rate and negative pressures on tradable goods
sector due to deterioration of its competitiveness in international markets.
5
However, there exists an alternative view on the problem. Ricardian Equivalence Hypothesis stresses that the
borrowing is just deferred taxation. Reduction in taxes is surely to increase current fiscal deficit and therefore
requires borrowing. But economic agents are rational and they anticipate future tax increases that the
government would need to pay off its debts. That is why they in fact increase current private savings in order to
compensate fully for additional future tax burden. In pure formulation, as advocated by Robert Barro (1989), a
given tax cut and a fall in government saving will be exactly offset by growth of private savings so that all these
pressures allegedly stemming from bond financing of budget deficit simply will not happen: interest rates won’t
rise, private sector won’t crowd out etc. It should be noted that empirical evidence doesn’t support the presence
of Ricardian Equivalence in developing world and is rather inconclusive as far as developed countries are
concerned.
9
2.2.3
Running Down Foreign Exchange Reserves
Financing of budget deficit by running down foreign exchange reserves occurs when the
central bank first purchases government debt on primary or secondary market (or simply
grants a loan to the government) thereby injecting additional reserves to the economy and
then trades available foreign exchange reserves for domestic currency to offset the increase of
monetary base and money supply.
As long as the foreign exchange reserves are available, government can confidently finance
the deficit. However, when foreign exchange reserves dry up and approach the level that the
private sector believes to be critical, the result can be capital flight and the exchange rate
depreciation that adds to inflationary pressures (Ouanes and Thakur, 1997).
2.2.4
Accumulation of Arrears
Many contemporary researchers argue that there exists a special form of dealing with budget
deficit that in essence aims to hide it. In practice, the part of government spending gets
deferred through the accumulation of arrears and is supposed to be disbursed later in coming
fiscal years.
Government expenditure arrears, which indicate delays in government payments to suppliers
or creditors, have become an important fiscal issue in many transition economies. Arrears can
lead to underestimates of spending and of the size of the fiscal problem facing a country.
Since arrears are a form of forced deficit financing, the government’s borrowing requirement
is also understated, which leads to a distorted picture of the sources of credit expansion in the
economy. While deficit financing can allow the government to absorb more of the economy’s
resources than would otherwise be possible, this initial effect is offset as the rest of the
economy responds by raising suppliers’ prices or holding back payments for taxes and fees.
Unfortunately, expenditure arrears raise the cost of providing government services (Chu and
Hemming, 1991).
Arrears may also adversely affect the private sector’s expectations about the future
development of the economy. Economic agents may thus anticipate an increase in tax
pressure, higher inflation, as well as overall deterioration of financial conditions. These
negative expectations are likely to amplify the conventional “deficit-money-inflation” effects
that we have already reviewed. Furthermore, the arrears accumulated in previous periods may
pose a threat to be carried over to the future periods thus only postponing inflationary
pressure.
2.3
Specific Theoretical Hypotheses
2.3.1
Olivera-Tanzi Effect
It appears that the “budget deficit-inflation” link in fact exhibits a two-way interaction, i.e. not
only budget deficit through its impact on money and expectations produces inflationary
pressure, but also high inflation then has a feedback effect pushing up budget deficit.
Basically, this process works through significant lags in tax collection. The problem lies in the
fact that the time of tax obligations’ accrual and the time of actual payment do not coincide,
with payment usually made at a later date. In view of this, high inflation during such a time
lag reduces the real tax burden. We may therefore have the following self-strengthening
phenomenon: persistence of budget deficit props up inflation, which in turn lowers real tax
revenues; a fall in the real tax revenues then necessitates further increase in budget deficit and
so on. In economic literature this is usually referred to as the Olivera-Tanzi effect6.
6
This phenomenon was observed and documented for many Latin America countries.
10
As Sachs and Larain (1993) show, the evidence from developing world in the 1980s supports
the conclusion that this self-strengthening process may well destabilize an economy and lead
to a very high inflation.
2.3.2
Deferred Inflation Effect
Some researchers also argue that budget deficit financing by means of accumulating domestic
debt seems to just postpone the inflation tax. If government finances its deficit by printing
money now, then in the future the burden of servicing existing stock of government debt will
be easier. Interest payments that otherwise add to the next periods’ government expenditures
will not exert additional pressure on fiscal authority and the deficit will not increase over
time. As Sachs and Larrain (1993) put it, “borrowing today might postpone inflation, but at
the risk of even higher inflation in the future”.
Sargent and Wallace (1981) observed, that when fiscal authority sets the budget
independently, the monetary authority could only control the timing of inflation.
Let’s assume that initially there is no public debt yet and government budget is balanced.
Then, however, for some reasons (tax legislation or increasing expenditures) the government
starts running a deficit. If it is financed by selling domestic debt to the public, then, provided
that primary deficit remains unchanged, the overall deficit will grow because of the mounting
interest burden on the debt.
Later, as Sargent and Wallace (1981) stress, it may well be the case that public will be
reluctant to acquire more government debt, because they will doubt the government’s ability
to service it. They refer to this phenomenon as an assumption of an upper limit on the real
stock of debt relative to the size of economy. Then the only option is to use money printing
and to collect seigniorage. Provided that fiscal policy determines constraints for monetary
policy (i.e. both policies are coordinated so as to finance the budget deficit), the monetary
authority will be unable to control money supply and therefore inflation forever. In other
words, taking into account the extensive bond financing of the deficit that preceded the
critical moment (stock of debt has reached upper limit), “sooner or later, in a monetarist
economy, the result is additional inflation” (Sargent and Wallace, 1981). It is so because the
principal and interest on the debt accumulated up to now and issued to fight inflation must be
financed, at least partially, by seigniorage.
However, it seems noteworthy that public-debt-financed deficits do not necessitate a future
increase in inflation. The reason is that the government may temporarily defer inflationary
pressure so as to implement some sort of restructuring (expenditure cuts or tax increases)
before the economy closely approaches the upper limit on public debt.
2.3.3 New Fiscal Theory of Price Level
Recently a new direction of theory has emerged, which may also be seen as an extension of
the deferred inflation hypothesis. According to the new fiscal theory of the price level (see
Komulainen and Pirttila, 2000, Carzoneri, Cumby and Diba, 1998, Woodford, 1994) there can
be two regimes for price determination. Under so called “monetary dominant” regime,
monetary policy determines the price level, and fiscal policy remains reactive. The
government balances its intertemporal constraint taking the inflation as given. In the “fiscal
dominant” regime, in contrast, the price level is determined by the intertemporal budget
constraint. If the future surpluses fall short of financing the deficit, the price level must adjust
— increase, reducing the real value of the government debt. Monetary policy is reactive in
“fiscal dominant” regime: money supply just reacts to price level changes to bring the money
demand equation in balance.
2.4
Closing Remarks
Taking into account the above-mentioned theories, we settle on the following distinction:
11
 Short-term inflationary effects can be generated by Central bank (NBU) financing
(comprising direct NBU credits, and financing through T-Bill (OVDP) purchases on the
primary and secondary markets. This way of financing is directly related to monetary
growth;
 Borrowing from domestic private markets, from international markets, or financing
through accumulation of arrears does not necessary imply immediate emission. It may
lead, however, to inflationary pressures in the future, or even immediately through
expectations formation, if government lacks credibility.
Therefore, if empirical analysis finds, that overall fiscal imbalance is more important
determinant of the inflation, than its direct monetary growth component, we would be
inclined to conclude on fiscal dominancy of the economic policy options. In such a case, the
scope for the monetary policy is limited.
12
3.
DEVELOPMENTS
3.1
Definitions
There exist different versions of the definition of the budget deficit that may be appropriate
for our study.
A first distinction is that between the consolidated balance and separate balances of Central
and Local governments (in the following we refer to the consolidated version if the other is
not indicated). It seems logical to refer to a negative value of General Government balance
(i.e. to -(Government revenues - Government expenditures) as a deficit. By the Budget law,
local budgets are to have zero balances. However, in Ukrainian practice, extra revenues of the
local budgets are retained on special accounts and are not incorporated into consolidated
deficit after end of reporting period. Therefore, General Government balance series seems to
show periodic discrepancies with the Central government deficit financing, because of
changes in government accounts balances and nonzero local budget balances. So, for some
periods, GDEF-GBAL.
A second distinction is between the National (Ministry of Finance of Ukraine) definition and
the International (International Monetary Fund) definition of the deficit. The national
definition of the budget deficit financing7 includes both internal and external financing as well
as changes in government accounts balances. It is worth stressing that privatisation revenues
are not considered a component of the financing of the deficit. From the national
methodology viewpoint privatisation receipts are a Revenues side item.
IMF definition covers external financing, financing via T-bills, changes in direct Central Bank
credit to government, changes in government accounts balances. The set of government
accounts differs from those included in the national definition. IMF considers changes of the
balances of all extra budgetary funds incorporated in monetary statistics as part of the deficit
definition8. National definition accounts only for income balances of budget entities while
calculating the balance.
A third distinction lies between accrual basis deficit (including arrears in payables to
government entities of different levels) and cash basis data. The latter variant is adopted in
our paper. Extra budgetary funds operations also might be taken into account, but due to
legislative changes, it appears difficult to find reliable series. For example the State’s Pension
Fund was possessing permanent deficits since 1994, but this quasi-fiscal balance was not
incorporated into the consolidated budget, except in the year 1996.
7
See Act of Verkhovna Rada (Ukrainian Parliament) “On Structure of the Budget Classification”, July, 12, 1996,
# 327
8
According to the IMF (1999) deficit consist of the following items: (1) total net treasury bill sales (total funds
raised net of total interest repayment); (2) other net banking system credit to government (all non-treasury-bill
financing extended to the budget by banks less all government deposits in the banking system); (3) receipts from
privatisation; (4) all credit guaranteed by the government; (5) net proceeds from bonds issued by local
authorities for the purpose of financing deficits of the consolidated budget; (6) net proceeds from bonds issued
by the government to non-residents for deficit financing: (7) the difference between disbursements of foreign
credits to the consolidated budget and the amortization of foreign credits by the consolidated budget; (8) the
decline in government deposits in non-resident banks.
13
3.2
Dynamics
The annual budget deficit to GDP ratio has been steadily declining (with the exception of
1997). It started in 1995 from the highly unbalanced point of 13,2% GDP and improved to
less then 1,5% GDP in 1999. For the first 3 quarters of 2000 a budget surplus of 1% GDP was
observed.
Figure 2. Consolidated Budget Deficit and Inflation Rate
%
15
1000
Deficit
log CPI
100
log
CPI, %
% GDP
10
8,9
5
10
6,6
4,9
6,6
2,2
1,5
1998
1999
0
1994
1995
1996
1997
1
Source: State Treasury, State Statistics Committee. Calculations: ICPS
Key determinants of the high level of budget deficit during 1993-1995 were extensive social
security obligations, over-optimistic forecasts of both budget revenues and the macro
environment.
Though all these features did not cease to exist, the period of hyperinflation and high
macroeconomic instability, unrealistic social security spending level were partly terminated in
1995.
However, new possibilities for deficit financing, and unwillingness to cut public spending
yielded a fallback to a 6,6% deficit in 1997.
The political attempt to introduce an “Economic Growth” program, featuring tax reform,
failed in late 1996, consequently producing a return to distorted public outlays, including
subsidies to inefficient producers and social security overspending9.
The average consolidated deficit level fall from 8,6% in the 1992-1995 to 3,8% of GDP in the
stabilization episode of 1996-1998. The introduction of the new currency along with more
tight monetary and foreign exchange policy lowered CPI inflation to 10,5% average in 1998.
The financial crisis of 1998 influenced heavily the macroeconomic performance, creating
macroeconomic instability. Forced rescheduling of government securities caused a final
drying up of borrowing possibilities on private markets, both domestic and foreign.
The suspension of external financing left the government no choice but to cut expenditures.
The impounding of funds was used several times to meet current budget constraints. This
"stabilizer" helped push the budget deficit towards 1,5 % GDP in 1999. More careful planning
and pro-reform government seems to be taking the budget balance turn positive in the year
2000.
9
See HIID (1999).
14
Figure 3. Quarterly Budget Deficit, Mln UAH
3000
General government
Central government
2000
General government, IMF definition
00Q3
99Q4
99Q1
98Q2
97Q3
96Q4
0
96Q1
Mln UAH
1000
-1000
-2000
Source: State Treasury, State Statistics Committee. Calculations: ICPS
Privatisation revenues make general government deficit (national definition) smaller,
especially their influence is clear starting from the end of 1998.
Figure 4. Quarterly Budget Deficit, % GDP
12,0
General government
General government, IMF definition
10,0
8,0
6,0
4,0
Privatisation revenues
2,0
00Q2
99Q3
98Q4
98Q1
97Q2
96Q3
95Q4
-2,0
95Q1
0,0
-4,0
Source: State Treasury, UEPLAC. Calculations: ICPS
3.3
Financing
The structure of the budget deficit financing was determined by different mechanisms
available to authorities: external borrowing, direct financing by NBU credits, financing
through T-bills market by private borrowing and by NBU purchases, then via secondary TBills market.
15
3.3.1
Direct NBU financing
Unrealistic planning of budget revenues and significant government interference into the
economy resulted in huge deficits of 1992-1995. The only source of financing was NBU
credit to Ministry of Finance. For instance, external government borrowing in 1994 was
covering less than 1% of the total.
3.3.2
External Financing
The rehabilitation loan in the amount of 398 mln USD and EU bilateral agreement credit of
100 mln USD formed the major sources of external financing in 1995. Meanwhile we see
gradual growth of external financing share, mainly by the World Bank (roughly 56%), EU
and Japan in 1996.
Table 1. Gross Emission of Commercial Loans*, 1996-1998
mln USD
Consortium
1996
1997
1998
Chase Manhattan Bank Luxembourg S.A.
110
572
281
Bankers Trust Luxembourg S.A.
450
533
0
E.M. Sovereign Investments
0
504
-245
Bavarian United Bank
0
129
-36
*This table covers only the so-called fiduciary loans: the loans guaranteed by a third party, i.e. foreign
commercial bank, but not by Ukrainian government directly.
To compensate for a negative net disbursement of Tbills in the Fall of 1997, government was
forced to search for funds on private markets. Two tranches of hryvnia denominated hedged
securities were issued in December 1997 and August 1998. The December issue raised 750M
UAH through Merrill Lynch and the August issue, roughly 330M UAH through ING Barings
bank.
Figure 5. Consolidated Deficit Financing
%
100%
Domestic
borrowing
80%
60%
External
borrowing
40%
NBU direct
credit
20%
0%
1995
1996
1997
1998
1999
Source: State Treasury, UEPLAC, NBU. Calculations: ICPS
To improve the situation further, the Finance Ministry has issued three groups of eurobonds.
First, Ukraine received ECU 488M from Euro-denominated Eurobonds floated in ECU in
March, 1998. In May of the same year a second tranche of deutsche mark-denominated threeyear Eurobonds generated DEM 259.35M.
16
External borrowing from official creditors has substantially contributed to financing in 1997,
bringing to budget gross 600 mln USD, from the conditional World Bank loans, EU and other
official creditors. The following year this borrowing decreased, resulting in a decline of the
external financing share.
Figure 6. Consolidated Deficit Financing By T-bills
% of government balance
150
Current deficit financing
120
Net financing
90
60
30
99Q4
99Q1
98Q2
97Q3
96Q4
-30
96Q1
0
-60
Source: State Treasury. Calculations: ICPS
3.3.3
T-bills (OVDP) Financing
The consequences of NBU direct financing had proved that the elimination of this mechanism
was required to provide a sound commitment to lowering inflation. Ukraine’s T-bill market
was created in the second quarter of 1995. The terms of circulation were 1-, 2-, 3-, 6-, 9-, 12and 18-months. The new bonds had fixed redemption date, and were structured as short-term
and long-term securities. Most of the long-term securities have been purchased by the NBU.
Figure 7. Deficit Financing Sources by Origin
Q3'99
Q4'98
Q1'98
Q2'97
Q3'96
Q4'95
Q1'95
%
0
-2
-4
-6
Bonds
-8
External
-10
NBU
-12
Source: State Treasury, UEPLAC. Calculations: ICPS
17
In 1996 T-bills financing had reached the level of some 23% of the total. The discount version
of T-bills was introduced in May, 1996. Also the secondary market was established. Access to
Tbills was secured for foreign investors in the fall of 1996. Strong inflow of funds started.
Figure 8. Nominal Domestic Debt Stock and Effective Rate of Return
mln UAH (left scale), % annual rate (right scale)
20000
300
18000
16000
14000
Domestic debt stock
250
Rate of return
200
12000
10000
150
8000
100
6000
4000
50
2000
99Q3
99Q1
98Q3
98Q1
97Q3
97Q1
96Q3
96Q1
95Q3
0
95Q1
0
Source: State Treasury, State Statistics Committee. Calculations: ICPS
The performance of T-bills markett was relatively positive till mid-1997. After the Fall
of 1997, foreigners began to withdraw their funds from this market and NBU purchases grew
to be the majority share.
In 1999, the current deficit was financed by means of domestic loans. Until the beginning of
December 1999 the government issued OVDP (T-bills) totalling to 2048 mln Hrn. The
growing volume of domestic financing is to a large extent being caused by the shortage of
external sources of funds. Because of the crash of the domestic borrowing market in August
1998, the NBU had remained the major buyer. After the approval of law giving the National
Bank a new status, direct purchases of T-bIlls for budget financing was legally prohibited,
thus forcing NBU to transfer T-bills through the secondary market using Oschadbank as a
primary buyer.
3.4
Inflation Performance
As we have shown earlier, different types of financing affect prices in different ways. The
direct financing mechanism theoretically influences the inflation rate via monetary base
expansion. Tbills (domestic borrowing) financing induces effects by crowding out for
Investment and Net Exports i.e. indirectly. The result may vary with the exchange rate policy.
There is a choice of inflation indicators among consumer, producer prices or GDP deflator.
CPI should react fast enough to changes in monetary policy. However, PPI seems to capture
more of the exogenous shocks and imported inflation. The GDP deflator would be a good
choice. Unfortunately, the latter is hard to estimate correctly, given the current availability of
Ukrainian Statistics.
18
Figure 9. CPI Subindices
December 1995 = 1
3,0
Food Index
Service Index
Non-food index
2,8
2,6
2,4
2,2
2,0
1,8
1,6
1,4
1,2
1,0
1995:12
1996:06
1996:12
1997:06
1997:12
1998:06
1998:12
1999:06
1999:12
Source: State Statistics Committee. Calculations: ICPS
In evaluating the influence of deficit financing on inflation, the problem arises as to how to
eliminate administrative and other exogenous shocks like the increases in household utilities
in 1995-1998 and imported price shock of August 1998.
The utility shock could be clearly seen from the utilities prices graph that shows kinks in
January 1996, April 1996, July 1996 due to administrative tariff adjustments to eliminate
subsidies to households. There was also an adjustment in April 1999.
Figure 10. Budget Balance and Inflation
%
20
Budget deficit, % of GDP
15
CPI average monthly change,%
10
5
Q1'00
Q3'99
Q1'99
Q3'98
Q1'98
Q3'97
Q1'97
Q3'96
Q1'96
Q3'95
Q1'95
0
-5
Source: State Statistics Committee. Calculations: ICPS
19
The part of the monetary base expansion due to fiscal imbalance could be approximated by
the change in domestic credit of NBU to the government. In Figure 11, we can observe its
lagged influence on inflation, with varying magnitude.
Figure 11. Change in NBU Credit to Government and Inflation
mln UAH (left scale), % (right scale)
4500
20
Change in NBU
credit to government
(left scale)
Average monthly
CPI change (right
scale)
Average monthly
PPI change (right
scale)
4000
3500
3000
2500
2000
1500
15
10
5
1000
500
0
00Q3
00Q1
99Q3
99Q1
98Q3
98Q1
97Q3
97Q1
96Q3
96Q1
95Q3
-500
95Q1
0
-5
Source: NBU. Calculations: ICPS
Until the begining of the crisis in August 1998, the central bank was able to neutralize the
results of expansionary fiscal policy. Nevertheless the central bank's participation at the
primary OVDPs auctions has changed its role from passive agent of the Ministry of Finance
into active participant of the T-bills market.
As we have mentioned in the theoretical section, the NBU sometimes is able to increase it’s
T-bills holdings without holding a large effect on money aggregates.The growth of budgetary
liabilities at the central bank has not had a direct inflationary consequences due to the
negative sterilization policy followed by NBU until the middle of 1998. The central bank was
channeling money to government (by new TBills purchases) and simultaneously made the
conversion for that part of Tbills withdrawn by non-residents from the market, decreasing the
level of foreign reserves and keeping the monetary base rather stable.
20
4.
EMPIRICAL ANALYSIS
4.1
Methodology
The purpose of this section is to empirically examine inflationary response to budget deficits,
if any, when related variables, such as base money growth, exchange rate, domestic budget
financing by NBU are taken into account. We test whether the price level is fiscal-dominantly
determined10. We are also going to explore which part of the inflation variability is explained
mostly by budget financing needs and which is influenced by other factors.
Rejection of the fiscal-dominancy hypothesis may be only implicit, because of possible crossrelationships that neutralize the direct effect of budget financing through monetary measures.
Similarly, finding that the government balance affects prices itself does not directly imply that
the impact of the monetary factors is lower or absent.
We chose the class of non-structural Vector Auto Regression (VAR) models for this analysis.
Attempts to identify the components separately either in AR or structural specifications have
failed in the sense that we obtain both poor econometric properties and weak economic
inference. So we have tried to capture the mutual effect of variables associated with inflation
to determine their net effect.
It may be interesting to impose additional restrictions and consider structural VAR, but it is
hard to identify whether fiscal or monetary disturbances in the Blanchard-Quah (1989)
decomposition should be considered permanent11. Another candidate for the model
specification, Vector Error Correction (VEC) model, was not supported by the cointegration
tests12.
Table 2. Data Used for the Estimation
Mnemonics13
Description
Unit
Source
CPI
Consumer Price Index
MBASE
Monetary Base
Mln UAH
National Bank of Ukraine
EXRATE
Official Exchange Rate,
period average
UAH/ USD
National Bank of Ukraine
MA_CLG
Net claims on Government
Mln. UAH
International Financial Statistics
GBAL
General Government
Balance
Mln UAH
State Treasury
State Statistics Committee
We have examined specifications with the following features:
 The price level tends to be the most endogenous variable while the others are considered
more exogenous. The last exogenous, and hopefully the most powerful, is the fiscal deficit
series or its transformations;
 The specification includes 5 variables: consumer prices (CPI), exchange rate (EXRATE),
monetary base (MBASE), NBU net credit to government (MA_CLG), and budget balance
10
In contrast, the money-dominant regime would show that the inflation depends only on money supply, so it is
the monetary phenomena only.
11
In other words, it is near impossible to find out which shocks are permanent, and which are temporary.
12
We still expect some long-run relationship between money and prices to hold. This is to be the subject for a
closer examination, but is beyond the scope of this paper.
13
In addition, the following mnemonics are used: LOG denotes logarithm of the variable, HF denotes HPF filter,
SA denotes Seasonally Adjusted by X-11.2 series, D denotes the first different, D(X,2) denotes the first
difference.
21
itself (GBAL). The ordering of the variables is important in VAR analysis, so we sort out
variables as follows: CPI, MBASE, EXRATE, MA_CLG, GBAL;
 The general VAR specification is:
n
pt   t   Ai pt i  BX t   t
i 1
where pt is the transformed variables vector , pt-i , are the lagged variables vectors, Xt are
the explanatory variables, matrices Ai, B to be estimated.
We have examined the sample of monthly data for 1995:1- 2000:6. The results of quarterly
regressions have shown significant loss in explanatory power, so we remained with the
volatile but more responsive monthly frequency. Table 2 reports the sources of the data,
whereas summary statistics of the original and transformed VAR series are presented in
Appendix 1. Government balance is the general government balance, using national
definition, and is negative for a deficit.
4.2
Regression Results
According to the Augmented Dickey-Fuller test results (Appendix 2), prices, monetary
aggregates, credit to government and exchange rate appear to be I(1) processes with trend and
drift, though the government balance seems to be I(0) i.e. stationary in levels. Thus we
differentiated once all series except GBAL, which is left in levels.
Pairwise Granger causality tests (Granger, 1969) are shown in Appendix 3. It becomes clear
NBU financing may directly affect the prices. However, we have not enough evidence to
reject the null hypothesis of no causality from budget balance to prices.
The regression results are shown in Appendix 4, whereas Appendix 7 covers the impulse
response functions (IRF), a short-run dynamic one and a cumulative one for the steady state14,
and the variance decomposition. Appendix 5 assures that stability of the underlying AR
scheme in VAR holds. All roots lie inside the unit circle that guarantees the lag polynomial
stability. We chose the lag length of 2 after the concurrent testing and examination of various
cross-correlation relationships (see Appendix 6).
The discovered VAR scheme is dynamically stable and rapidly converge to steady state. The
GBAL equation is the weakest part of the model, however not weak enough to ignore GBAL
effect. Some of the regressors are correlated, so it’s hard to analyze the corresponding tstatistics. Nevertheless, the estimation method generates consistent unbiased estimates for the
model coefficients. Chow forecast test couldn’t reject the hypothesis of no structural break for
financial crisis 1998.
The largest cumulative effect on inflation rate has the inflation itself. A 1% increase in
inflation generates 2.5% more inflation over the next year (2% over the 6 months).
Inflationary impacts of the monetization of the budget deficit and the budget deficit itself are
of same magnitude. Dynamic cumulative elasticity15 of the price level to the NBU claims to
government equals 0.4. A 1% increase in the stock of the credit to government leads to 0.4%
of inflation over the year. The biggest impact is on 3-5 month after the shock.
14
The interpretation of the impulse response functions (IRF) graphs is that they demonstrate dynamic responses of
the inflation change to innovations in other variables.
15
The dynamic semi-log elasticity (Pindyk and Rubienfeld, 1998) is calculated following the formula
EYX ( ) 
X t Yt   Yt

Yt
X t
.
22
On average, an increase in the deficit of 1% GDP16 leads to 0.38% inflation over the next
year. As the average monthly GDP and the stock of NBU credit to government are very close
amounts, same percentage change in both leads to roughly equal inflationary response.
Somewhat surprisingly, regression results show exchange rate and monetary base dynamics
have very low, if any, influence on prices17. We tend to explain this finding by supposedly the
same monetary nature of the monetary base, the claims to government, and the exchange rate.
Thus, the model finds the most linked variable, diminishing the marginal contribution of the
others.
Forecast-error decomposition illustrates that steady state configuration of CPI inflation
variance is distributed 10% due to growth of the NBU credit. Exchange rate and budget
balance variations yield approximately 3% explanation to inflation each. The monetary base
growth explains less than 1% of the inflation variability.
4.3
Policy Implications
The empirical estimation demonstrates the existence of complicated links between fiscal
deficits, money, and inflation in Ukraine. We could hardly expect to find clear and linear
structural coefficients that would provide policymakers with clear-cut recipes in the economy
undergoing structural changes.
At the same time, the VAR analysis leads us to the tentative economic policy implications:

although more possibilities, not just monetization, emerged to finance fiscal deficit in
the second half of the 1990s (through T-bills market and from external sources), the
fiscal imbalance still has a substantial inflationary impact. In our opinion, it suggests a
lack of credibility in government debt management. Even if the government managed
to attract funds from the public, economic agents do not trust the government would not
be forced to reverse to monetization. Therefore the price level starts to grow in
expectation of later monetization not far away. Financial crisis of 1998, when T-bills
market fell, is the strongest example. It is crucial now to restore credibility to the
government securities, for deficit to be less inflationary;

cutting budget deficit is disinflationary, even more so when monetization share is
falling. In the extreme case, a monthly 1% GDP decrease in budget deficit, all of which
was previously monetized, subtracts 0.8% from annual inflation. If a non-monetized
share of the deficit is eliminated, annual inflation is lowered by 0.4%;

the monetary policy conduct in Ukraine largely depends a lot on a stance of the fiscal
policy. The model suggests that in order to neutralize the inflationary effect of the fiscal
expansion, the NBU need to decrease its credit to the government. However, previous
experience shows, that it is hardly possible.

inflationary inertia has a strong disinflationary potential. Once authorities manage to
cut a monthly inflation rate by one 1%, the benefit is tripled over the year.
Finally, a note of caution should be made. The model we examined in this paper is not
universal. For example, it fails to incorporate possible influence of real sector of the economy.
Various exogenous shocks, like discrete administrative price increases certainly lower the
explanatory power of the model. Therefore, as a forecasting tool the model might be used
very cautiously.
16
To get the dynamic impact multiplier in terms of GDP, we multiplied the coefficient from the model by an
average monthly GDP. The average monthly GDP over the period 1995:1-2000:6 was 8545 mln UAH. The
coefficient, obtained directly from the model, answers the question: how disinflationary is a 1 mln UAH cut of
the deficit?
17
The exchange rate change seems to be highly inflationary during the first 3 months after the shock, but later on it
is being compensated.
23
5.
CONCLUSIONS
The purpose of this paper was to evaluate the importance of budget deficit for inflation in
Ukraine in the second half of the 1990s. We find that fiscal imbalance, apart from other,
purely monetary factors, does affect the level of inflation determination. A monthly decrease
of budget deficit by 1%GDP, all of which was previously monetized, leads to decrease of
annual inflation by 0.8%. If a non-monetized part of the deficit is eliminated, annual inflation
is lowered by 0.4%. Among the monetary factors, the monetization of the deficit seems to be
the most inflationary. The dynamics of the National Bank’s claims to government
(monetization) appear to be more tightly linked to the inflation than the monetary base and the
exchange rate. Since the budget policy remains an important inflationary factor, the room for
an independent monetary policy remains limited.
24
6.
REFERENCES
Banaian, King, Bolgarin, Igor, and Georges de Menil, 1998, “Inflation and Money in
Ukraine,” Delta Working Paper No. 198-06, 14 pp.
Barro, Robert J., 1989, “The Ricardian Approach to Budget Deficits“, Journal of Economic
Perspectives, Vol.3, Spring
Blanchard, Olivier, and D. Quah, 1989, “The Dynamic Effects of Aggregate Demand and
Supply Disturbances”, American Economic Review 79.
Carzoneri, M., Cumby, R., and B. Diba, 1998, “Is the Price Level determined by the Needs of
Fiscal Solvency?”, NBER Working Paper #6471
Chu, Ke-Young and Richard Hemming, eds., 1991, Public Expenditure Handbook,
Washington, D.C.: International Monetary Fund
de Menil Georges, 1997, “The volatile relationship between deficits and inflation in Ukraine,
1992-1996,” Economics of Transition, Vol. 5(2), pp. 485-497.
Dornbusch, Rudiger, Fischer, Stanley and Richard Startz, 1998, Macroeconomics. –7th ed.,
Boston-Dubuque-Madison-New York: Irwin/McGraw-Hill
Fiscal Policy and New Instruments of Budget Deficit Financing in Ukraine, 1999, HIID
Working Paper
Granger, C. W. .J. 1969, “Investigating Causal Relations by Econometric Models and CrossSpectral Methods,” Econometrica, 37, 424–438.
Komulainen, Tuomas, and Jukka Pirttila, 2000, “Fiscal Explanation for Inflation: Any
Evidence from Transition Economies”, BOFIT Discussion Papers #11.
Markiewicz , Malgorzata, 1998, “Interrelations between monetary and fiscal policy in
Ukraine”, HIID/CASE Working Papers
Mishkin, Frederic S. 2000, The Economics of Money, Banking, and Financial Markets,
Boston - San-Francisco – New York: Addison Wesley
Open Budget 1999 for Ukraine, 1999, ed. A. Gonciarz et al.,UEPLAC, ICPS, Institute of
Reforms.
Ouanes, Abdessatar and Subhash Thakur, 1997, Macroeconomic Accounting and Analysis in
Transition Economies, Washington, D.C.: International Monetary Fund
Pindyck, Robert S., and Daniel L. Rubinfeld, 1998, Econometric Models and Economic
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Sargent, Thomas and Neil Wallace, 1981, “Some Unpleasant Monetarist Arithmetic”, Federal
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Ukraine Economic Trends, UEPLAC, various issues, 1998-2000
Ukraine--Technical Memorandum, 1999, Letter of Intent of the government of Ukraine,
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Vakhnenko, Tatiana, 2000, State Debt of the Ukraine and it’s Economical Consequences.
Walsh E. Carl, 1998, Monetary Theory and Policy. MIT Press, Cambridge, Massachusetts,
London, England
Woodford, Michael, 1994, “Monetary Policy and Price Level Determinacy in a Cash-inAdvance Economy”, Economic Theory, 4, 345-380
25
7.
APPENDICES
Appendix 1. Data Used in the Estimation
Stationary Series Graphs
.20
.30
.16
.25
.20
.12
.15
.08
.10
.04
.05
.00
.00
-.04
-.05
1995
1996
1997
1998
1999
1995
1996
DLOG(CPI)
1997
1998
1999
DLOG(EXRATE)
.25
.20
.20
.15
.15
.10
.10
.05
.05
.00
.00
-.05
-.05
-.10
-.10
1995
1996
1997
1998
1995
1999
1996
1997
1998
1999
DLOG(MA_CLG)
DLOG(MBASE)
800
400
0
-400
-800
-1200
-1600
1995
1996
1997
1998
1999
GBAL
26
Original Series Graphs
35
6
30
5
25
4
20
15
3
10
2
5
0
1
1995
1996
1997
1998
1999
1995
1996
CPI
1997
1998
1999
EXRATE
16000
24000
14000
20000
12000
16000
10000
8000
12000
6000
8000
4000
4000
2000
0
0
1995
1996
1997
1998
1999
1995
MBASE
1996
1997
1998
1999
MA_CLG
Summary Statistics
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Sum
Sum Sq. Dev.
Observations
DLOG(CPI)
0.030208
0.015873
0.192272
-0.010050
0.038387
2.282945
8.818993
150.4471
0.000000
1.993737
0.095780
66
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Sum
Sum Sq. Dev.
CPI
17.87530
17.69375
30.86976
5.095265
6.136360
-0.063575
2.639760
0.401335
0.818184
1179.770
2447.569
DLOG(EXRATE)
0.025029
0.007649
0.289432
-0.031324
0.051489
2.879105
13.67761
404.7128
0.000000
1.651902
0.172325
66
EXRATE
2.632824
1.882672
5.543100
1.172000
1.323945
1.028380
2.602049
12.06871
0.002395
173.7664
113.9340
GBAL
-225.5905
-202.5290
779.7972
-1221.000
331.5991
-0.307773
5.741517
21.71073
0.000019
-14888.98
7147269.
66
DLOG(MA_CLG)
0.041290
0.026195
0.210979
-0.061903
0.050048
1.080060
4.604015
19.90719
0.000048
2.725140
0.162810
66
MBASE
6722.512
6668.000
14025.00
1409.196
3318.025
0.462127
2.266566
3.828470
0.147455
443685.8
7.16E+08
MA_CLG
9857.083
7017.845
21525.84
1445.900
6106.564
0.564182
1.915644
6.734838
0.034479
650567.5
2.42E+09
DLOG(MBASE)
0.033637
0.026617
0.192222
-0.077805
0.054344
0.669356
3.688655
6.232586
0.044321
2.220017
0.191960
66
27
Appendix 2. Augmented Dickey-Fuller Unit Root Tests Results
*,**,*** denotes rejection of Unit Root Hypothesis at 1%,5% 10% significance level respectively
Variable
ADF Test Statistic
LOG(CPI)
-2.419940
10% Critical Value -3.2712
GBAL
-6.046655***
1% Critical Value -3.2778
LOG(EXRATE)
-2.159280
10% Critical Value -3.1689
LOG(MBASE)
-1.181760
10% Critical Value -3.1902
LOG(MA_CLG)
-2.784070
10% Critical Value -2.9804
============================================================
DLOG(CPI)
-4.601403 ***
1% Critical Value -4.1162
D(LOG(EXRATE))
-4.278143***
1% Critical Value -3.5417
D(LOG(MA_CLG))
-5.590083**
5% Critical Value -3.5417
D(LOG(MBASE))
-3.149715**
5% Critical Value -2.91
28
Appendix 3. Granger Causality Tests
Dependent variable: DLOG(CPI)
Exclude
DLOG(EXRATE)
GBAL
DLOG(MA_CLG)
DLOG(MBASE)
All
Prob.
0.1400
0.4402
0.0249
0.8719
0.0072
Dependent variable: DLOG(EXRATE)
Exclude
DLOG(CPI)
GBAL
DLOG(MA_CLG)
DLOG(MBASE)
All
Prob.
0.0708
0.7822
0.0013
0.4049
0.0125
Dependent variable: GBAL
Exclude
DLOG(CPI)
DLOG(EXRATE)
DLOG(MA_CLG)
DLOG(MBASE)
All
Prob.
0.5381
0.2072
0.8708
0.5321
0.7260
Dependent variable: DLOG(MA_CLG)
Exclude
DLOG(CPI)
DLOG(EXRATE)
GBAL
DLOG(MBASE)
All
Prob.
0.0114
0.0201
0.0759
0.7754
0.0436
Dependent variable: DLOG(MBASE)
Exclude
DLOG(CPI)
DLOG(EXRATE)
GBAL
DLOG(MA_CLG)
All
Prob.
0.1549
0.2431
0.0076
0.7187
0.0115
29
Appendix 4. VAR Results
Sample: 1995:01 2000:06
Included observations: 66
Standard errors in ( ) & t-statistics in [ ]
DLOG(CPI)
DLOG
(EXRATE)
GBAL
DLOG
(MA_CLG)
DLOG
(MBASE)
DLOG(CPI(-1))
0.583690
(0.12919)
[ 4.51800]
-0.689619
(0.32786)
[-2.10339]
-1885.645
(2108.28)
[-0.89440]
0.699626
(0.31919)
[ 2.19187]
0.668665
(0.37036)
[ 1.80543]
DLOG(CPI(-2))
0.103697
(0.07824)
[ 1.32530]
0.455499
(0.19857)
[ 2.29394]
1407.466
(1276.87)
[ 1.10228]
-0.184807
(0.19332)
[-0.95598]
-0.282562
(0.22431)
[-1.25971]
DLOG(EXRATE(-1))
0.108056
(0.06424)
[ 1.68214]
0.314781
(0.16302)
[ 1.93093]
1859.440
(1048.29)
[ 1.77378]
-0.286640
(0.15871)
[-1.80606]
0.039956
(0.18415)
[ 0.21697]
DLOG(EXRATE(-2))
-0.064766
(0.04960)
[-1.30580]
-0.039316
(0.12587)
[-0.31235]
-199.7765
(809.404)
[-0.24682]
-0.222767
(0.12254)
[-1.81787]
-0.239024
(0.14219)
[-1.68104]
GBAL(-1)
-1.19E-05
(9.9E-06)
[-1.19291]
1.02E-05
(2.5E-05)
[ 0.40444]
-0.069737
(0.16226)
[-0.42978]
4.62E-06
(2.5E-05)
[ 0.18822]
6.17E-05
(2.9E-05)
[ 2.16499]
GBAL(-2)
-4.08E-06
(9.7E-06)
[-0.41983]
1.37E-05
(2.5E-05)
[ 0.55611]
-0.058172
(0.15871)
[-0.36652]
5.42E-05
(2.4E-05)
[ 2.25412]
6.04E-05
(2.8E-05)
[ 2.16782]
DLOG(MA_CLG(-1))
-0.084799
(0.05546)
[-1.52913]
0.497553
(0.14073)
[ 3.53541]
-296.9982
(904.979)
[-0.32818]
0.155333
(0.13701)
[ 1.13371]
0.110526
(0.15898)
[ 0.69523]
DLOG(MA_CLG(-2))
0.149116
(0.06115)
[ 2.43842]
0.056955
(0.15519)
[ 0.36700]
-360.0961
(997.945)
[-0.36084]
0.455314
(0.15109)
[ 3.01357]
0.055961
(0.17531)
[ 0.31921]
DLOG(MBASE(-1))
-0.025603
(0.05596)
[-0.45756]
-0.190145
(0.14200)
[-1.33903]
-303.5398
(913.135)
[-0.33242]
-0.092044
(0.13825)
[-0.66579]
0.136986
(0.16041)
[ 0.85397]
DLOG(MBASE(-2))
0.013424
(0.04774)
[ 0.28117]
-0.005419
(0.12116)
[-0.04473]
849.8445
(779.117)
[ 1.09078]
-0.025497
(0.11796)
[-0.21615]
0.181670
(0.13687)
[ 1.32733]
C
-0.001123
(0.00479)
[-0.23441]
0.831333
24.15124
-5.022012
-4.638049
0.030375
0.040157
0.012405
(0.01216)
[ 1.02004]
0.381905
3.027579
-3.159435
-2.775472
0.026367
0.053236
-317.8943
(78.2028)
[-4.06500]
0.202790
0.561372
14.37815
14.76212
-259.3232
284.1327
0.033497
(0.01184)
[ 2.82921]
0.369665
2.873639
-3.213030
-2.829066
0.043953
0.051322
0.042078
(0.01374)
[ 3.06290]
0.295468
2.054974
-2.915645
-2.531682
0.034385
0.056327
R-squared
F-statistic
Akaike AIC
Schwarz SC
Mean dependent
S.D. dependent
30
Appendix 5. Stability of VAR scheme
Inverse Roots of AR Characteristic Polynomial
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
31
Appendix 6 Cross Correlations
Cross Correlation of Inflation and Government Balance
DLOG(CPI),GBAL(-i)
DLOG(CPI),GBAL(+i)
i
lag
lead
. |* .
|
. |* .
|
0
0.0793
0.0793
. | .
|
. | .
|
1
-0.0001
-0.0235
. *| .
|
. *| .
|
2
-0.0471
-0.1455
. | .
|
. *| .
|
3
0.0037
-0.0993
. | .
|
. | .
|
4
0.0273
-0.0330
. |* .
|
. *| .
|
5
0.0650
-0.0604
. | .
|
. *| .
|
6
-0.0193
-0.0780
. | .
|
. |* .
|
7
0.0256
0.0874
. | .
|
. | .
|
8
0.0247
-0.0130
. | .
|
. *| .
|
9
0.0143
-0.0832
. | .
|
.**| .
|
10 -0.0149
-0.1956
. |* .
|
***| .
|
11 0.0728
-0.3026
. |* .
|
. *| .
|
12 0.1014
-0.0841
Correlations for Contemporaneous Values of Variables Examined
DLOG
(CPI)
DLOG
(EXRATE)
GBAL
DLOG
(MA_CLG)
DLOG
(MBASE)
DLOG(CPI)
1.000000
0.359639
0.079294
0.412247
0.080164
DLOG(EXRATE)
0.359639
1.000000
0.218213
0.292892
-0.036861
GBAL
0.079294
0.218213
1.000000
-0.043771
-0.416832
DLOG(MA_CLG)
0.412247
0.292892
-0.043771
1.000000
0.272543
DLOG(MBASE)
0.080164
-0.036861
-0.416832
0.272543
1.000000
32
Appendix 7. Effects of VAR components on Inflation
Impulse Response Functions
Response to Nonfactorized One Unit Innovations
Response of DLOG(CPI) to DLOG(CPI)
Response of DLOG(CPI) to DLOG(EXRATE)
1.2
.5
1.0
.4
0.8
.3
0.6
.2
0.4
.1
0.2
.0
0.0
-.1
-0.2
-.2
1
2
3
4
5
6
7
8
9
10
11
12
1
Response of DLOG(CPI) to GBAL
2
3
4
5
6
7
8
9
10
11
12
Response of DLOG(CPI) to DLOG(MA_CLG)
.00001
.5
.00000
.4
.3
-.00001
.2
-.00002
.1
-.00003
.0
-.00004
-.1
-.00005
-.2
1
2
3
4
5
6
7
8
9
10
11
12
1
2
3
4
5
6
7
8
9
10
11
12
Response of DLOG(CPI) to DLOG(MBASE)
.4
.2
.0
-.2
-.4
1
2
3
4
5
6
7
8
9
10
11
12
33
Impulse Response Functions (cumulative effect)
Accumulated Response to Nonfactorized One Unit Innovations
Accumulated Response of DLOG(CPI) to DLOG(CPI) Accumulated Response of DLOG(CPI) to DLOG(EXRATE)
4
0.8
3
0.4
2
0.0
1
-0.4
0
-0.8
-1
1
2
3
4
5
6
7
8
9
10
11
12
1
Accumulated Response of DLOG(CPI) to GBAL
0.8
.00004
0.4
.00000
0.0
-.00004
-0.4
-.00008
-0.8
2
3
4
5
6
7
8
9
10
11
3
4
5
6
7
8
9
10
11
12
Accumulated Response of DLOG(CPI) to DLOG(MA_CLG)
.00008
1
2
12
1
2
3
4
5
6
7
8
9
10
11
12
Accumulated Response of DLOG(CPI) to DLOG(MBASE)
0.8
0.4
0.0
-0.4
-0.8
1
2
3
4
5
6
7
8
9
10
11
12
34
Variance Decomposition
Variance Decomposition
Percent DLOG(CPI) variance due to DLOG(CPI)
Percent DLOG(CPI) variance due to DLOG(EXRATE)
100
20
80
16
60
12
40
8
20
4
0
0
1
2
3
4
5
6
7
8
9
10
11
12
1
Percent DLOG(CPI) variance due to GBAL
2
3
4
5
6
7
8
9
10
11
12
Percent DLOG(CPI) variance due to DLOG(MA_CLG)
20
20
16
16
12
12
8
8
4
4
0
0
1
2
3
4
5
6
7
8
9
10
11
12
1
2
3
4
5
6
7
8
9
10
11
12
Percent DLOG(CPI) variance due to DLOG(MBASE)
20
16
12
8
4
0
1
2
3
4
5
6
7
8
9
10
11
12
35