The fiscal policies in the contemporaneous economic systems heavy influence both the real and nominal sectors. These effects could be located at the primary distribution of the social resources as will as at level their redistribution one. The aims of this paper are: (1) to review the literature of the main conceptual frameworks which link the fiscal policy and the dynamic of real sector, especially on the inflation side (2) to advance an empirical analyze of these link for the Romanian case and (3) to draw some conclusion about desirable framework of the fiscal policy for the current period in the perspective of Romanian access to European Union.Impact, inflation, fiscal policy, econometric analyze, fiscal deficit, budgetary sold

Dima, Bogdan

Mutascu, Mihai

Talpos, Ioan

English

Research Papers in Economics

Ioan Talpoş 
West University of Timişoara, Faculty of Economics, Timişoara, Romania 
ioan.talpos@fse.uvt.ro 
 
Bogdan Dima  
West University of Timişoara, Faculty of Economics, Timişoara, Romania 
bogdan.dima@fse.uvt.ro, bogdandima2001@yahoo.com 
 
Mihai Mutaşcu  
West University of Timişoara, Faculty of Economics, Timişoara, Romania 
mihai.mutascu@fse.uvt.ro, mmutascu74@yahoo.com 
 
 
 
THE FISCAL POLICY AND THE STABILITY OF THE NOMINAL SECTOR:  
THE ROMANIAN CASE 
 
Keywords: impact, inflation, fiscal policy, econometric analyze, fiscal deficit, budgetary sold 
 
Abstract: the fiscal policies in the contemporaneous economic systems heavy influence both 
the real and nominal sectors. These effects could be located at the primary distribution of the 
social resources as will as at level their redistribution one.  
The aims of this paper are: (1) to review the literature of the main conceptual frameworks 
which link the fiscal policy and the dynamic of real sector, especially on the inflation side (2) 
to advance an empirical analyze of these link for the Romanian case and (3) to draw some 
conclusion  about  desirable  framework  of  the  fiscal  policy  for  the  current  period  in  the 
perspective of Romanian access to European Union. 
 
 
1. INTRODUCTION 
 
Specialized International economic literature identifies two types of theoretical approaches 
regarding the link between inflation and fiscal policy: on one side an approach promoted by 
Sargent and Wallace (1981) known as „The Theory of inflationary fiscal deficit”, on the other 
side  an  approach  formulated  by  Leeper  (1991),  Woodford  (1995,  1997,  1998)  and  Sims 
(1994) known as „The Theory of fiscal determination of the level of prices”. 
The theory of the inflationary fiscal deficit tries to explain, on long term, to what extent do big 
and persistent deficits determine the in the increase of price indexes and which are the precise 
ways to counteract their negative effect. 
The theory of fiscal determination of the level of prices introduces in equation the effects 
emitted over the inflation by the adjustments of fiscal policy and evaluates the measure in 
which these can be quantized using empirical investigations. Moreover, it is considered that 
the  level  of  price  must  correspond  with  that  point  because the real value  of public debt 
equalizes the present value of future budget excess, ensuring this way an intertemporal budget 
balance. 
 
 
2. THEORETICAL FUNDAMENTS 
 
 
Knowing  the  monetary  nature  of  the  inflation,  economic  literatures  study  the  relations 
between fiscal and monetary policy, as well as the results on their impact over inflation. We  
2
remark,  as  a  matter  of  fact  the  interaction  between  the  powers  of  two  characteristic 
authorities: on one side the Govern as a principle promoter of fiscal policy and on the other 
side the Central Bank, as a forum of conceiving and applying monetary policy. However, if 
there is a high level of govern implication in monetary policy 
There’s  a  big  probability  that  the  Central  Bank  will  use  its  power  this  way.  In  such 
circumstances the Govern can force the Central Bank to accept direct financing of the budget 
deficit or to maintain the refinancing installment at a low level, so that the cost for public 
credit remains low. 
Thus, according to Barro and Gordon (1983), a high level of independence of the Central 
Bank  can  induce  a  high  level  of  price  indexes  when  the  bank  tries  to  maintain  fiscal 
sustainability in the economy with cost levels as small as possible. 
Cotarelli et al. (1998) sums up the fact that there is a big impact of fiscal deficit over the 
inflation, especially in countries in which money markets aren’t highly developed, suggesting 
limited access of governs on those markets and their propensity to ask for help from the 
Central Bank. 
 
 
3. METHOD AND RESULTS 
 
 
In order to test the links between the inflation and some budgetary macro-variables (public 
revenues and public expenditures) a Vector Error Correction (VEC) could be involved. The 
VEC methodology presents several advantages. In particular, it allows building a model of 
the connections between some co-integrated variables, being extremely useful in the study of 
the economic fluctuations. 
 A VEC model is a particular restricted Vector Error (VAR) model designed for use with 
non-stationary series that are known to be co-integrated. The VEC has co-integration relations 
built  into  the  specification  so  that  it  restricts  the  long-run  behavior  of  the  endogenous 
variables  to  converge  to  their  co-integrating  relationships  while  allowing  for  short-run 
adjustment dynamics. The co-integration term is known as the error correction term since the 
deviation from long-run equilibrium is corrected gradually through a series of partial short-
run adjustments. 
 
To take the simplest possible example, consider a two variable system with one co-integrating 
equation and no lagged difference terms. The co-integrating equation is: 
 
( ) 1 , 1 , 2 t t y y β =  
 
The corresponding VEC model is: 
 
( )
( ) ( ) 2 , 2 1 , 1 1 , 2 2 , 2
, 1 1 , 1 1 , 2 1 , 1
t t t t
t t t t
y y y
y y y
ε β α
ε β α
+ − = ∆
+ − = ∆
− −
− −
 
 
In this simple model, the only right-hand side variable is the error correction term. In long run 
equilibrium, this term is zero. However, if  1 y  and  2 y  deviate from the long run equilibrium, 
the error correction term will be nonzero and each variable adjusts to partially restore the 
equilibrium  relation.  The  coefficient  i α   measures  the  speed  of  adjustment  of  the  i-th 
endogenous variable towards the equilibrium. 
 
The vector of the endogenous variables has the following representation:  
3
 
 
[ ] t t t t CHP   VP IFP Y =               (3)  
 
where: IFP - variations in the level of inflation, VP - variations in the level of public revenues, 
CHP - variations in the level of public expenditures and t represent the current period t. 
Variations that can be expressed as: 
 
100
1
*
X
X
ln x
t
t
t  


 


=
−
   (4) 
 
For presenting how such a model can be applied in approaching the inter-connections between 
inflation, public revenues and their allocation, in an instable economic system, as in Romania, 
we propose an analysis made for September 1998 - February 2006 period, which was shaped 
by important changes in the fiscal policy. The seasonal effects are drawn from the original 
data by the usage of an X12-ARIMA procedure in order to preserve the main linkages between 
the involved variables. 
 
 
The  estimation  of  the  general  model  parameters  described  by  the  relation  (3)  leads  to 
following results (Table 1): 
 
Table 1 
 
The estimation of the general model parameters 
 
 Vector Error Correction Estimates 
 Sample (adjusted): 1998M09 2006M02 
 Included observations: 90 after adjustments 
 Standard errors in ( ) & t-statistics in [ ] 
       
Co-integration  Equations:  CointEq1  CointEq2   
       
IFP_SA(-1)   1.000000   0.000000   
VP_SA(-1)   0.000000   1.000000   
CHP_SA(-1)  -0.121268  -0.987180   
   (0.15076)   (0.04532)   
  [-0.80437]  [-21.7811]   
       
Error Correction:  D(IFP_SA)  D(VP_SA)  D(CHP_SA) 
       
CointEq1  -3.484849   0.339747   0.417828 
   (0.65697)   (0.40320)   (0.47844) 
  [-5.30443]  [ 0.84263]  [ 0.87331] 
       
CointEq2   0.707002  -1.539876   3.783575 
   (1.93197)   (1.18570)   (1.40698) 
  [ 0.36595]  [-1.29870]  [ 2.68915] 
       
D(IFP_SA(-1))   1.776156  -0.261404  -0.297071 
   (0.60261)   (0.36984)   (0.43886) 
  [ 2.94742]  [-0.70680]  [-0.67692]  
4
       
D(IFP_SA(-2))   1.250112  -0.086798  -0.033489 
   (0.52170)   (0.32018)   (0.37993) 
  [ 2.39623]  [-0.27109]  [-0.08814] 
       
D(IFP_SA(-3))   0.829707   0.044485   0.097809 
   (0.42754)   (0.26239)   (0.31136) 
  [ 1.94067]  [ 0.16954]  [ 0.31414] 
       
D(IFP_SA(-4))   0.565959   0.194190   0.208546 
   (0.32927)   (0.20208)   (0.23980) 
  [ 1.71882]  [ 0.96094]  [ 0.86968] 
       
D(IFP_SA(-5))   0.280116   0.178092   0.170884 
   (0.22334)   (0.13707)   (0.16265) 
  [ 1.25419]  [ 1.29925]  [ 1.05061] 
       
D(IFP_SA(-6))   0.109537   0.110427   0.159296 
   (0.11776)   (0.07227)   (0.08576) 
  [ 0.93014]  [ 1.52788]  [ 1.85741] 
       
D(VP_SA(-1))  -0.749446   0.274743  -2.912283 
   (1.79659)   (1.10262)   (1.30838) 
  [-0.41715]  [ 0.24917]  [-2.22586] 
       
D(VP_SA(-2))  -0.483834   0.079978  -2.338285 
   (1.55060)   (0.95165)   (1.12924) 
  [-0.31203]  [ 0.08404]  [-2.07067] 
       
D(VP_SA(-3))  -0.393756   0.034259  -1.585941 
   (1.24430)   (0.76366)   (0.90618) 
  [-0.31645]  [ 0.04486]  [-1.75015] 
       
D(VP_SA(-4))  -0.224125  -0.006198  -0.984099 
   (0.91252)   (0.56004)   (0.66455) 
  [-0.24561]  [-0.01107]  [-1.48084] 
       
D(VP_SA(-5))  -0.309432   0.026622  -0.434388 
   (0.58661)   (0.36002)   (0.42721) 
  [-0.52749]  [ 0.07395]  [-1.01681] 
       
D(VP_SA(-6))  -0.462769   0.005969  -0.224912 
   (0.28386)   (0.17421)   (0.20672) 
  [-1.63028]  [ 0.03426]  [-1.08799] 
       
D(CHP_SA(-1))   0.323032  -1.220108   1.993025 
   (1.76780)   (1.08495)   (1.28742) 
  [ 0.18273]  [-1.12458]  [ 1.54808] 
       
D(CHP_SA(-2))   0.168435  -0.950095   1.416570 
   (1.53023)   (0.93914)   (1.11440) 
  [ 0.11007]  [-1.01166]  [ 1.27115] 
        
5
D(CHP_SA(-3))  -0.304227  -0.675289   0.993805 
   (1.22347)   (0.75088)   (0.89100) 
  [-0.24866]  [-0.89934]  [ 1.11538] 
       
D(CHP_SA(-4))  -0.383627  -0.416561   0.587370 
   (0.89551)   (0.54960)   (0.65216) 
  [-0.42839]  [-0.75794]  [ 0.90065] 
       
D(CHP_SA(-5))  -0.057684  -0.195213   0.380009 
   (0.56026)   (0.34385)   (0.40801) 
  [-0.10296]  [-0.56773]  [ 0.93136] 
       
D(CHP_SA(-6))  -0.010279  -0.044648   0.185624 
   (0.24374)   (0.14959)   (0.17750) 
  [-0.04217]  [-0.29847]  [ 1.04574] 
       
 R-squared   0.829071   0.581438   0.772351 
 Adj. R-squared   0.782676   0.467829   0.710560 
 Sum sq. residuals   146216.9   55074.22   77547.85 
 S.E. equation   45.70354   28.04950   33.28403 
 F-statistic   17.86979   5.117862   12.49952 
 Log likelihood  -460.3911  -416.4527  -431.8523 
 Akaike AIC   10.67536   9.698949   10.04116 
 Schwarz SC   11.23087   10.25446   10.59668 
 Mean dependent  -0.885597   0.237035   0.017577 
 S.D. dependent   98.03825   38.45027   61.86670 
       
 Determinant residuals covariance (degree of freedom adj.)   6.99E+08   
 Determinant residuals covariance   3.29E+08   
 Log likelihood  -1265.645   
 Akaike information criterion   29.59210   
 Schwarz information criterion   31.42530   
       
         
Based on these results we could consider that this model satisfactory describes the connection 
between  implicated variables. Its  use allow us to  make  an approximation  of the  impulse 
function form, which estimates the inflation evolution caused by a shock in the revenues level 
(Chart 1) or in the public expenditures level (Chart 2).  
 
 
 
 
 
 
 
 
 
 
 
  
6
-40
-30
-20
-10
0
10
20
30
40
50
1 2 3 4 5 6 7 8 9 10 11 12
Response of IFP_SA to VP_SA
Response to Cholesky One S.D. Innovations
 
Chart 1 - Effects on inflation caused by a shock in public revenues level 
 
 
 
-40
-30
-20
-10
0
10
20
30
40
50
1 2 3 4 5 6 7 8 9 10 11 12
Response of IFP_SA to CHP_SA
Response to Cholesky One S.D. Innovations
 
Chart 2 - Effects on inflation caused by a shock in public expenditures level 
 
 
 
 
  
7
4. DISCUSSIONS 
 
As the impulse function shows, a shock in the public revenues exercises initially a week 
response of the inflation, followed in a two period interval by a “down” adjustment, and after 
that the inducted effects reach a “peak” in two quarters and are slowly absorbed after that. A 
similar set of effects could be observed for the effects of the public expenditures on the 
inflation behaviour.  
It  is  important  to  remark  that  the  ensemble  of  these  effects  is  “short-termed”,  reaching 
maximal levels in first two post-impact quarters. In other words, changes in the configuration 
of public decision mentioned determinants are fast and instable rebounded upon the dynamic 
of  revenues  and  expenditures  flows, determining frequent inter-correlated  adjustment and 
exerting a “fast” reaction on the prices formation mechanisms. 
 
 
5. CONCLUSIONS 
 
The analysis presented in this paper had in mind to envisage the way of manifestation of the 
correlation between public resources, their allocation and the prices evolution. 
 
Results obtained suggest the existence of some “fast” adjustment processes inducted by the 
intrinsic characteristics of the fiscal policy, by the specific behaviour of the public authorities, 
particularities that are active in adoption and application of the public decision and also by the 
imperfect correlation between the fiscal and monetary policies. In other words, the impact of 
the fiscal policy on the costs levels, the modalities chosen by the public authorities to finance 
the public deficit as well as the inflationary expectations induced to the economic subjects 
could “counter-balance” the effects of a restrictive monetary policy. 
 
The main analytical development directions are: 
•  Widening of conceptual framework taken into consideration explicitly determinant 
factors of correlation between public revenues and public expenditures; 
•  Adoption  of  some  alternative  methodologies  for  empirical  testing  of  these 
determinants way of manifestation; 
•  Taking into consideration the case of other emerging economic systems. 
 
 
REFERENCES 
 
1. Barro, R. J. and D. Gordon (1983), “A positive theory of monetary policy in a natural rate 
model”, Journal of Political Economy, Vol. 91, No. 4, pp. 589–610. 
2. Cottarelli, C., M. Griffiths and R. Moghadam (1998), “The Nonmonetary Determinants of 
Inflation: A Panel Data Study”, IMF Working Paper, WP/98/23. 
3. Dima, B. (2001), „Inflaţia structurală în România”, Ed. Augusta, Timişoara. 
4.  Leeper,  Eric  (1991),  “Equilibrium  under  ‘Active’  and  ‘Passive’  Monetary  Policies”, 
Journal of Monetary Economics 27(1), pp. 129-147. 
5. Mutaşcu, M. (2005), „Finanţe publice”, Ed. Artpres & Augusta, Timişoara.   
6.  Rother,  P.C.  (2004),  “Fiscal  Policy  and  Inflation  Volatility”,  Working  Paper  Series, 
No.317, pp. 8-9.  
7.  Sargent,  T.  and N.  Wallace (1981), “Some unpleasant monetarist arithmetic”,  Federal 
Reserve Bank of Minneapolis Quarterly Review, Fall, pp. 1–17. 
8. Sims, Christopher A. (1994), “A Simple Model for Study of the Determination of the Price 
Level and of the Interaction of Monetary and Fiscal Policy”, Economic Theory, 43(3), 381-
399.  
8
9. Talpoş, I (1999), “Creditul public”, Ed. Sedona, Timişoara. 
10. Talpoş, I (1995), “Finanţele României”, Ed. Sedona, Timişoara. 
11.  Woodford,  M.  (1998),  “Comment  on  ‘A  frictionless  view  of  U.S.  inflation’  by John 
Cochrane”, NBER Macroeconomics Annual, No. 13, pp. 390–419. 
 

A positive theory of monetary policy in a natural rate model”,

A Simple Model for Study of the Determination of the Price

Comment on ‘A frictionless view of U.S. inflation’ by John Cochrane”,

Equilibrium under ‘Active’ and ‘Passive’ Monetary Policies”,

Inflaţia structurală în România”,

Some unpleasant monetarist arithmetic”, Federal Reserve Bank of Minneapolis Quarterly Review, Fall,

The Nonmonetary Determinants of Inflation: A Panel Data Study”,

THE FISCAL POLICY AND THE STABILITY OF THE NOMINAL SECTOR: THE ROMANIAN CASE

THE FISCAL POLICY AND THE STABILITY OF THE NOMINAL SECTOR: THE ROMANIAN CASE

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