The Threshold Impact of Fiscal and Monetary Policies on Inflation: Threshold Model Approach

The aim of this study is to examine the nonlinear effects of fiscal and monetary policies on inflation during 1990:3 to 2013:1 based on threshold model. First lag of the liquidity growth is recognized as threshold variable with threshold value estimated at 6.37 percent. In low liquidity growth, the results indicate that inflation expectations and the lagged liquidity growth are the most important determinants of inflation. In high liquidity growth, effects of the variables including liquidity, development and con-current expenditure, exchange rate, budget deficit and inflationary expectations are much stronger than low one.  GDP and its lag in both regimes are anti-inflationary as expected. Oil revenues have no inflationary effects in both regimes, so it seems that the effect of oil shocks on inflation is captured by other variables such as exchange rate and money growth. Based on results, it seems that liquidity growth can be considered as the most important factor for regime change in the relationship between inflation and fiscal and monetary policies in the economy. So if economy benefits from the low liquidity regime, it can prevent the inflationary effects of variables like government expenditure or exchange rate and use the opportunity to control inflation expectations. It is recommendable, in low liquidity regime to use fiscal, monetary and exchange rate policies to stimulate production and real sector with low inflationary effects. Keywords: Inflation, Inflationary Regimes, Threshold Model, Nonlinear Model JEL Classification: E31, H5, C01