ABSTRACT
This paper examines the nonlinear relationship between inflation and government spending
using quarterly data over the period of 1990-2013, by using Smooth Transition Regression Model.
Results suggested a two regime model by using inflation, government expenditure growth, GDP
growth and liquidity growth. Lag of liquidity was recognized as transition variable. This study showed
that in regime of tight money or low growth of liquidity, government expenditure is not inflationary.
In regime of low growth of liquidity, this variable has low inflationary impact and probably stimulates
economic growth. Inflationary expectations in first regime are more effective in causing short run
inflation. In expansionary regime, increase of money supply has more effects on inflation rather than
production. So monetary and fiscal policies could be used to control inflation and stimulate aggregate
demand in low regime. Also in easy money regime, monetary and fiscal discipline can be useful for
inflation decrease.
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