THE RULE OF LAW AND INFLATION IN THE MIDDLE-INCOME COUNTRIES

Abstract

The article analyzes the relationship between compliance with the rule of law and inflation. Annual data for the period of 2013—2019 of the Rule of Law Index from the non-governmental organization World Justice Project (WJP) for 40 countries of Central and Eastern Europe, the former Soviet Union, Asia and Latin America were used. By means of cross-section estimates and panel data using a random effects model (RE), the dependence of inflation on individual WJP sub-indices was empirically estimated, taking into account a wide analytical spectrum of different aspects of the rule of law. Recently, the issue of the rule of law is increasingly used in economic research. First of all, it concerns the dependence of transaction funds and trust on legal factors, which has a direct impact on the funds of production and inflation, as emphasized by the representatives of the new institutional school (New Institutional Economics). Instead, Neoclassical economics economists mainly analyze the influence of the rule of law mechanisms on the formation of trust in such institutions as the independent central bank or the state administrative apparatus. There is no lack of empirical evidence that the anti-inflationary influence of the central bank significantly depends on the concomitant conditions of compliance with the rule of law. Keynesian economics experts state that the importance of legal and regulatory norms increases significantly with a low interest rate (Zero Lower Bound — ZLB), which has been the case recently in most industrialized countries. Since the academic interpretation of the rule of law is quite broad, it is of practical interest to study the relevant macroeconomic effects in terms of such individual components as the system of counterbalances and checks for government, the fight against corruption, maintenance of law and order, efficiency of regulatory mechanisms, etc. The study showed that there is no reason to deny the anti-inflationary impact of the rule of law in general and in terms of individual components, but the obtained empirical estimates may be vulnerable to data aggregation and differ in terms of individual groups of countries. If we use the general index of the rule of law of the WJP, the anti-inflationary effect can be traced both for the general sample of 40 countries, and separately for both subgroups of countries: 1) Central and Eastern Europe (CEE) and the former Soviet Union, 2) Asia and Latin America. The use of WJP sub-indices shows an anti-inflationary effect for the general sample of countries and subgroups of CEE countries and the former Soviet Union (with a few exceptions), but the corresponding effect is completely lost for the countries of Asia and Latin America (it can mean that only complex simultaneous introduction of all components of the rule of law is anti-inflationary). This feature draws attention to the possibility of erroneous use of panel data estimates for large groups of countries that may not meet certain regional characteristics and incline to erroneous recommendations for economic policy. Among other results, weak signs of accelerating inflation have been observed over time in the CEE countries and the former Soviet Union, but not in Asia and Latin America. Also in these countries, inflation does not depend on GDP dynamics. In contrast, in the CEE and former Soviet Union countries, on average, each percentage point of GDP growth (lag per year) is marked by a 0.3-percentage-point decrease in inflation.

Keywords

• the rule of law
• inflation
• panel data