EXPLAINING FISCAL-POLICIES AND INFLATION IN DEVELOPING-COUNTRIES

In this paper we investigate empirically the determinants of inflation, seigniorage and fiscal deficits in developing countries. We first test the optimal taxation theory of inflation for a group of 21 LCDs. We find that the implications of this theory are rejected for all these countries. We then proceed to implement a number of tests based on the new political economy approach to macroeconomic policies: we deal with some of the implications of a credibility and reputation model, and of a strategic government behavior model. We find that the data support the most important predictions of the political economy view of fiscal policy. Our measures of political instability and political polarization play an important role in explaining cross country differences in seigniorage, inflation, government borrowing and fiscal deficits. We end by discussing directions for future research. © 1991.