ABSTRACT
This chapter shows that there is empirical support for a political economy explanation of inflation. While traditionally countries with lax fiscal and monetary policies generate inflation, the ability of a nation to maintain fiscal and monetary discipline depends on certain features of its particular political system. The chapter investigates empirically the relationship between the relative political extraction (RPE) of governments and their inflation performance. It develops a more complex model that incorporates political considerations to account for the inflationary process. The theoretical overview suggests both that the political capacity of governments to extract resources should affect budget deficits, and that potential links exist between budget deficits and money creation. Central to positive approach is an outline of the ways in which macroeconomic policy and performance are influenced by the organizational strengths of different decision makers and by the political and institutional environments in which they operate.
