Inflation, government expenditure and real income in the long-run

This paper examines the relationship between inflation and real income in Australia, Canada, Finland, New Zealand, Spain, Sweden and the UK which have adopted a "formal" policy of low or zero inflation target. Using cointegration analysis and a vector error correctin model (VECM), we find that the long-run relationship between inflation and real income is positive in most cases. We further find that contrary to the belief of new-classical economics, government expenditure too is positively related to real income in the long-run.