The infationary effect of the budget deficit : does financial sector development matter?

This study aims to examine the budget defcit-infation relationship, considering fnancial sector development and broad money supply as moderating and mediating variables. For this purpose, a panel data set ranging from polled mean group, mean group, and dynamic fxed efect estimation techniques are employed. Hence, the pooled mean group estimation result reveals that the budget defcit is infationary. In addition, GDP per capita, the efective exchange rate, fnancial sector development, regulatory quality, and the interaction term of the budget defcit and fnancial sector development are signifcant determinants of infation. The study further examines the role of the broad money supply as a mediating variable in the budget defcit-infation relationship. The structural equation model results and the mediation efect tests confrmed a partial mediation efect of the broad money supply on the budget defcit- infation relationship. Based on the fndings, it is recommended to strengthen regulatory quality, reduce broad money supply, and improve fnancial sector development. By doing so, we can create a more stable and efcient economy that benefts everyone in the long run.