3. New Fiscal Theory of Price Level

Recently a new direction of theory has emerged, which may also be seen as an extension of the deferred inflation hypothesis. According to the new fiscal theory of the price level (see Komulainen and Pirttila, 2000, Carzoneri, Cumby and Diba, 1998, Woodford, 1994) there can be two regimes for price determination. Under so called “monetary dominant” regime, monetary policy determines the price level, and fiscal policy remains reactive. The government balances its intertemporal constraint taking the inflation as given. In the “fiscal dominant” regime, in contrast, the price level is determined by the intertemporal budget constraint. If the future surpluses fall short of financing the deficit, the price level must adjust — increase, reducing the real value of the government debt. Monetary policy is reactive in “fiscal dominant” regime: money supply just reacts to price level changes to bring the money demand equation in balance.

4. Closing Remarks

Taking into account the above-mentioned theories, we settle on the following distinction:

• Short-term inflationary effects can be generated by Central bank (NBU) financing (comprising direct NBU credits, and financing through T-Bill (OVDP) purchases on the primary and secondary markets. This way of financing is directly related to monetary growth;

• Borrowing from domestic private markets, from international markets, or financing through accumulation of arrears does not necessary imply immediate emission. It may lead, however, to inflationary pressures in the future, or even immediately through expectations formation, if government lacks credibility.

Therefore, if empirical analysis finds, that overall fiscal imbalance is more important determinant of the inflation, than its direct monetary growth component, we would be inclined to conclude on fiscal dominancy of the economic policy options. In such a case, the scope for the monetary policy is limited.

3. Developments

   1. Definitions

There exist different versions of the definition of the budget deficit that may be appropriate for our study.

A first distinction is that between the consolidated balance and separate balances of Central and Local governments (in the following we refer to the consolidated version if the other is not indicated). It seems logical to refer to a negative value of General Government balance (i.e. to -(Government revenues - Government expenditures) as a deficit. By the Budget law, local budgets are to have zero balances. However, in Ukrainian practice, extra revenues of the local budgets are retained on special accounts and are not incorporated into consolidated deficit after end of reporting period. Therefore, General Government balance series seems to show periodic discrepancies with the Central government deficit financing, because of changes in government accounts balances and nonzero local budget balances. So, for some periods, GDEF-GBAL.

A second distinction is between the National (Ministry of Finance of Ukraine) definition and the International (International Monetary Fund) definition of the deficit. The national definition of the budget deficit financing⁷ includes both internal and external financing as well as changes in government accounts balances. It is worth stressing that privatisation revenues are not considered a component of the financing of the deficit. From the national methodology viewpoint privatisation receipts are a Revenues side item.

IMF definition covers external financing, financing via T-bills, changes in direct Central Bank credit to government, changes in government accounts balances. The set of government accounts differs from those included in the national definition. IMF considers changes of the balances of all extra budgetary funds incorporated in monetary statistics as part of the deficit definition⁸. National definition accounts only for income balances of budget entities while calculating the balance.

A third distinction lies between accrual basis deficit (including arrears in payables to government entities of different levels) and cash basis data. The latter variant is adopted in our paper. Extra budgetary funds operations also might be taken into account, but due to legislative changes, it appears difficult to find reliable series. For example the State’s Pension Fund was possessing permanent deficits since 1994, but this quasi-fiscal balance was not incorporated into the consolidated budget, except in the year 1996.