Money, Wages and Inflation in Middle-Income Developing Countries

Research on the sources of inflation in developing countries has often led economists to distinguish between the "fiscal" view and the "balance-of-payments" view of the inflationary process.1 Advocates of the fiscal view, while supporting the notion that inflation and excessive monetary growth are closely related, emphasize that the root cause of monetary growth in developing economies is often found in large fiscal imbalances. In many of these countries, inefficient revenue collection procedures and limited development of financial markets tends to increase reliance on seignorage as a source of financing of budget deficits. Factors such as the adverse effect of inflation itself on the real value of the fiscal deficit (the Olivera-Tanzi effect) also tend to reinforce the link between fiscal deficits, money growth, and inflation. By contrast, proponents of the balance-of-payments view have emphasized the induced effect of exchange rate movements (in the presence of an accommodative monetary policy stance) on domestic prices. Such movements-an exchange rate depreciation, for instance-are often the result of adverse developments in the balance of payments. In turn, such developments may reflect excessive government spending or exogenous shocks, such as a sharp deterioration in the terms of trade.2