Do Exchange Rates and Budget Deficit Lead to Inflation? A Panel Causality Analysis on Developing Asian Countries

In developing economies, budget deficit and exchange rates can lead inflation through shallow financial markets. In this study it is tested whether budget deficit and exchange rates cause inflation in long-run and short-run for 22 developing Asian countries for the time period of 1980 and 2011. The reason why we select all the developing countries from one region is that we assume all countries have fixed unit effect in the models. In this study we use panel cointegration, error correction model and panel causality methods as empiric test. Findings suggest that in short-run there is no causality running from exchange rate and budget deficit to inflation but in long-run budget deficit and exchange rates cause inflation.