**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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