Modelling the public sector deficit and inflation relationship in Turkey

Abstract

This study assesses the empirical relationship between the public sector deficit and inflation in Turkey using the cointegration analysis. Since 1986, the Treasury set a consistent, well defined institutional framework to monitor the selling of government bonds and bills in order to finance budget deficit of Turkey besides the issuance of base money by the Central Bank. Inflation is estimated by using scaled budget deficit, growth rate of real income, scaled stock of bonds, scaled interest paid and scaled base money. First, the time series properties of the data set are examined then, weak exogeneity of the independent variables and cointegration are tested. Next, both a single equation and a VAR model are estimated. Weak exogeneity and cointegration tests show that a VAR model is more reliable than a single equation model. The estimation of a VAR model indicates that inflation in Turkey is related solely to its first lag, implying that the Turkish inflation is inertial with about 35% of inertia.