Fighting Inflation in Developing Countries: Does Democracy Help? an Empirical Investigation

Abstract: In this paper using data covering the period 1960-2003, I find a causal, positive and significant effect of democracy on inflation in a sample of 62 developing countries former extractive colonies. Democracy increases inflation because democracy stimulates money creation and compromises trade liberalization in developing countries. However, when I exclude Latin American countries from my sample, the significant effect of democracy on inflation disappears. In addition, though the coefficient associated with democracy is no more significant, it is still positive after excluding Latin American countries from my sample. This suggests that the significant effect but not the positive effect of democracy on inflation in my sample is due to the experiences of Latin American countries. Thus, my results reconcile two views: one that “populist democracy” is a Latin American phenomenon, the other according to which democracy does not necessarily induce better macroeconomic management in developing countries. Case studies based on the experiences of Chile, Ghana and Sri Lanka illustrate the relationships between inflation and democracy in my sample.