Inflation targeting and public deficit in emerging countries: A time varying treatment effect approach

a r t i c l e i n f o Several studies including Minea et al. (2012) and Lucotte (2012) emphasize that in emerging countries, the adoption of inflation targeting (IT) monetary policy and its discipline character allow intensifying their efforts to collect tax revenue and/or expenditure rationalization, and allows the reduction of their budget deficits (Kadria and Ben Aissa, 2014). Nevertheless, the lag in the effect of monetary policy contains vital information for the policy evaluation (Fang and Miller, 2011). Hence, our contribution to the previous literature is then to evaluate the time varying treatment effect of the IT's adoption by emerging countries on their budgetary discipline in terms of reducing or mastering the public deficit. To do this, we used the propensity score matching approach in order to take account of this " lag effect " or from this effect throughout time. Our empirical analysis, conducted on a sample of 41 economies (20 IT and 21 non-IT economies) for the period from 1990 to 2010, shows that the lag in the effect of IT on public deficit performance proves to be shorter and gradual for emerging countries that have adopted this monetary policy framework. Our conclusions corroborate the literature disciplining effect of IT on fiscal policy. In recent decades, an extensive literature has focused on further analyzing the interactions that may exist between monetary and fiscal policies , mainly through the focus on the link between public deficit and inflation phenomenon. (2011) argue that the high rate of inflation, observed especially in many developing countries, is associated with important deficits, mainly financed by seigniorage revenue. agree on the fact that if the central bank decides to grant significant weight in its loss function to the price stability objective, it will reduce seigniorage revenue and compel the State to increase tax revenues through tax mobilization efforts. the inflation targeting (thereafter IT) policy has helped emerging inflation targeters (thereafter ITers) to have a significant improvement in macroeconomic performance which is mainly measured through the behavior of inflation, output, and interest rates. Nonetheless, this monetary strategy requires a process of economic and institutional reforms which have a relatively large disciplining effect on the conduct of fiscal policy in avoiding seigniorage revenue and therefore opting for a tax mobilization/ government expenditure rationalization and public deficit reduction. However, developed ITers have become more fiscally disciplined in order to reach the target within …