Introduction

This paper develops stylized facts about the inflationary process in developing countries, focusing particularly on the relationship between the exchange rate regime and the sources of inflation. To this end, we examine the influences on inflation in annual data from 1964 to 1998 for 53 developing countries grouped both by region – Africa, Asia, the Mediterranean, and South America – and by exchange rate regime – fixed or floating. This broad-brush approach of pooling countries together is intended to complement the many previous analyses of inflation in developing countries that have typically focused on the experience of individual countries or small groups of them.

We group sources of inflation into four categories. First, as discussed by Montiel (1989), inflation in developing countries is often linked to underlying fiscal imbalances. Such imbalances can lead to an increase in inflation either by triggering higher money growth, as in Sargent and Wallace (1981), or by triggering a balance of payments crisis and forcing an exchange rate depreciation, as in Liviatan and Piterman (1986). The interaction between inflation and the government budget constraint is also stressed in Razin and Sadka (1987) and Bruno and Fischer (1990).

Another possibility, examined by Coe and McDermott (1997) for 13 Asia economies, is that – as in the industrial countries – inflation in developing countries indicates an overheating economy and is influenced by an activity variable such as the output gap.