Government deficits and the inflationary process in Tanzania

The purpose of this study is to examine the relationship between increases in money supply and inflation in Tanzania over the period 1970-1979. The reactions of the government fiscal deficit to inflation is used to link growth of money supply and inflation in a two way relationship. The basic hypothesis is that an increase in the rate of inflation, whatever its cause, increases the amount of the fiscal deficit owing to the fact that while money expenditures keep pace with inflation, nominal revenues tend to lag behind. The financing of this deficits, usually through government borrowing from the central banks, increases money supply thus creating further inflation. Therefore, increases in the supply of money both causes inflation and is positively affected by it. This hypothesis is tested for Tanzania during the period 1970-79. The study was based on models, of monetary fiscal behaviour, consisting of five equations in five variables, viz, equations specifying the nature of price levels, money supply, government expenditure, government revenues and government deficit and their behavioral relationship. Before empirical evidence in support of the hypothesis is presented, the study gives a short analysis of the literature on inflation in Tanzanian, and also of the general literature on the relation between increases in prices and in money supply brought about mainly owing to the central bank financing of government deficit. The estimated model tend to validate the hypothesis. Financing of the fiscal deficits play an important role in the inflationary process and the increase in this deficit is largely owing to the differences in the lags of government expenditures and revenues. The basic policy conclusions emerging from this study are: since the government budgetary position is destabilizing an actively anti-inflationary fiscal policy is desirable. Further a priority should be attached to tax reforms to eliminate revenue leakages and lags. In view of the expanding government sector which necessitates increased expenditures, a fair measure of price control is necessary as a remedy for the already felt inflationary pressure. This should however be accompanied by tightening government expenditures, tax structure reforms and adherence to the statutory limits of government borrowing from the Bank of Tanzania.