Investigating the dynamic nexus between fiscal deficit and inflation: empirical evidence from BRICS economies

The debate surrounding whether fiscal actions are responsible for inflation has been a central focus in macro-public finance. In this regard, the present study makes a novel attempt to assess the nexus between fiscal deficit and inflation in the presence of output growth, trade openness and money supply using a balanced panel dataset from Brazil, Russia, India, China, and South Africa (BRICS) economies. In conducting the empirical analysis, the study initially addresses the issues of cross-section dependency, heterogeneous slope coefficients and nonstationarity. The assessment of long-run cointegration was carried out by using novel third-generation cointegration tests introduced by Westerlund and Edgerton (2008) and Banerjee and Carrion-i-Silvestre (2017). The authors utilise the advanced and latest estimation technique, the cross-section augmented autoregressive-distributed lag (CS-ARDL) model, for long-run and short-run analyses. Finally, to investigate the causal relationship between fiscal deficit and inflation within a panel framework, this study employs the novel test (JKS) introduced by Juodis et al. (2021). Using recent econometric tests, the study validates the existence of cross-sectional dependency and slope heterogeneity. The results of the third-generation cointegration test by Westerlund and Edgerton (2008) and Banerjee and Carrion-i-Silvestre (2017) show that the variables are cointegrated in the long run. The CS-ARDL model revealed a positive relationship between inflation and fiscal deficit. The implication of this finding suggests that the fiscal deficit plays an inflationary role in BRICS economies. Finally, the JKS causality test results found a bi-directional causal association between fiscal deficit and inflation. The findings suggest several significant policy recommendations. It is recommended that a well-executed fiscal consolidation strategy be adopted to attain sound fiscal health and lower inflation. A disciplined fiscal approach is not only vital for effective monetary policy but also essential for maintaining macroeconomic stability. Monetary authorities must establish credible practices to effectively manage the macroeconomic system, and policy stances should align with the specific needs of the economy. The bidirectional causality between fiscal deficit and inflation suggests that relying solely on fiscal measures is inadequate for managing inflationary pressures or stabilising fiscal balances. Thus, a more comprehensive approach is required, including measures such as sustaining economic growth, reducing import dependency, diversifying exports and ensuring exchange rate stability. Numerous empirical studies have explored the link between fiscal deficit and inflation. However, most research studies within BRICS economies have focused on individual countries rather than considering the group as a whole. This limited scope may fail to capture the unique characteristics and interactions within these economies. To the best of the author’s knowledge, the present study is the first attempt to examine the issue from a panel perspective across BRICS economies. The methodological novelty of the present study is that it represents the first attempt, at least within emerging market economies, to investigate the nexus between fiscal deficit and inflation using second- and third-generation econometric models. From a policy perspective, the authors highlight that BRICS economies must prioritise fiscal discipline through measures such as reducing unproductive expenditure and improving tax collection. Close coordination between fiscal and monetary authorities is essential to ensuring that monetary policy supports fiscal consolidation efforts while maintaining price stability.