Inflation, government expenditure and real income in the long‐run

This paper examines the relationship between inflation and real income in Australia, Canada, Finland, New Zealand, Spain, Sweden and the UK which have adopted a “formal” policy of low or zero inflation target. Using cointegration analysis and a vector error correction model (VECM)), we find that the long‐run relationship between inflation and real income is positive in most cases. We further find that contrary to the belief of new‐classical economics, government expenditure too is positively related to real income in the long‐run.