Abstract:
This paper investigates the short-run dynamics and long-run relationship between budget deficit, its sources of financing and inflation in Egypt using annual data for the period 1981/82-2005/06. The empirical results of Johansen cointegration analysis suggest that in the long-run inflation is not only related to the budget deficit but also to its sources of financing, real output growth and the exchange rate. In a vector error correction model (VECM), significant error correction coefficients suggest a two way dynamic interaction between the budget deficit, credit to the government, exchange rate and inflation in Egypt. The paper concludes that budget deficit and its sources of financing remain important drivers of inflationary pressures in Egypt, making targeting price stability problematic. Strengthening the fiscal position by reducing the budget deficit and net government debt, promoting economic growth and introducing greater exchange rate flexibility are crucial for supporting monetary policy in curbing inflationary pressures in Egypt.
