Journal of Economics and Behavioral Studies (ISSN: 2220-6140) Vol. 9, No. 6, pp. 174-187, December 2017 174 Inflation Dynamics in Algeria Samer Mehibel * , Yacine Belarbi Centre de Recherche en Economie Appliquée pour le Développement, Algeria samer.mehibel@gmail.com * , belarbiyacine@yahoo.fr Abstract: In thispaper, we analyze Inflation Dynamics in Algeria between 2002 and 2016. We use a Vector Auto Regressive model (VAR), impulse response functions (IRF) and variance error decomposition (VDC) to uncover possible links between public spending component sand inflation. Wetest for the sources and dynamics of inflation in Algeria by focusing on public spending, since they are expected to exert a strong influence on the aggregate demand and hence inflation. According to the results we found, inflation in Algeria is persistent; shocks are lasting longer and having impact on the future inflation path. Social transfers and equipment spending are found to be the most contributing components of public spending in explaining inflation in Algeria. Keywords: Inflation dynamics, Inflation persistence, The Algerian economy, Demand-pull inflation 1. Introduction In the first decade of this century, inflation has known a stabilized situation. In 2005, the inflation rate dropped to 1.6% after hitting an unprecedented level Algeria never experienced since its independence estimated at 0.34% in 2000. Between 2005 and 2011 inflation rate in Algeria registered a slight increase to reach 4.5% in 2011 but in 2012 a very important hike was recorded of about 11% which was explained by the increase in food prices (+19.6 percent for fresh food) and manufactured goods prices. Higher prices were spurred by the excess liquidity resulting from the surge in current public spending and large hydrocarbon income (IMF, 2012). In 2013 inflation rate reached 4.5% which was the rate targeted by the bank of Algeria. While it retreated in 2014 to average 2.9 percent, average year-on-year inflation exceeded the 4 percent target of the Bank of Algeria in 2015. It was partly driven by higher import price inflation, suggesting some degree of exchange rate pass-through as the dinar depreciated significantly against major currencies in 2015.In fact starting from mid-2014, inflation started accelerating again gradually to reach 6.9 percent average year-on-year by December 2016 as a consequence of a sustained rise in manufactured goods prices, which represented 55% on average to overall inflation. In 2016, a significant fluctuation in food prices was the origin of the peak of inflation registered in July of about 8.1 percent before decreasing for a while, then increased once again toward the end of the year. An IMF study on the causes of inflation in Algeria, IMF (2013) 1 pointed out that a decrease of loans to the public sector by more than 20% in 2012, contributed to increase the inflationary pressures, while loans growth to the private sector decreased by 10% in 2012. The monetary authorities raised the mandatory reserve on deposits in the banking system from 9 to 11% by expanding the absorption of liquidity estimated at 250 billion AD (23%). This study was preceded by another study, Koranchelian, (2004) found that both real and monetary factors have an impact on inflation. Inflation is associated in the long term positively with money supply and the exchange rate and negatively with income. Thus, the rising incomes of the families do not have a positive impact on the high rate of Inflation. The author suggested that the monetary authorities must continue a prudent monetary policy to cope the inflationary pressures. Ben Naceur (2012) by studying the short and the long-run determinants of inflation in Algeria for the period from 2002 to 2011 found that only non-oil GDP gap explains inflation in the short run and in the long run he found money supply and real GDP to be the most important determinants of inflation. An important aspect of fiscal policy in Algeria is its procyclical character (Menna & Mehibel, 2017; Chibi et al., 2014) and its impact on inflation (Menna & Mehibel, 2017). The aspect of cyclicality has the potential of putting pressures of instability in the economy 2 , such as rising inflation. Among the first reasons cited by the 2 “SiklikalitasKebijakanFiskal di Indonesia”, Research Note No.11/15/DKM/BRE/CR, Bank Indonesia.