Impact of Inflation on Fiscal Deficits in the Bangladesh Economy

This paper investigates the two-way relationship between fiscal deficits and inflation in Bangladesh’s economy. A dynamic model containing inflation and equations concerning government revenue and development expenditures has been constructed and estimated, using quarterly data over the 1974(11)-1983(11) period. Estimates of adjustment parameters support the basic hypothesis that in Bangladesh government expenditures adjust themselves to inflation more rapidly than government revenues and increase the size of fiscal deficits during inflation. An implication of this result is that inflation-induced fiscal deficits (if financed by money creation) may generate a self-sustaining inflationary process in a developing country like Bangladesh.