Budget Deficit Financing in Tanzania: Implications for Price Stabilization

Abstract

The study investigates whether budget deficit financing modes have differential implications on general price level in Tanzania. The study employs the co-integration and error correction modeling approach to examine the short-term and long-term effects of budget deficit financing on inflation. The study finds that the effects of budget deficit on general price level depends significantly on its financing modes. The results reveal that while domestic financing is inflationary foreign financing is deflationary. The results further show that seigniorage revenue financed budget deficit has no significant effect on price level whereas grants financed budget deficit has significant inflationary outcome. Moreover, the study finds that budget deficit financed by drawing down excess foreign reserves would mitigate inflation. Thus, to combat budget deficit oriented inflationary pressure, the government has to opt for external borrowing as opposed to internal borrowing and foreign aids in the nature of grants. In addition, the central bank has to control money supply and foreign reserves in such a way the additional money supply does not exceed expansion of the economy and excess foreign reserves could be used to finance budget deficit.