ELIMINATING THE INFLATIONARY FINANCE TRAP IN A POLITICALLY UNSTABLE COUNTRY: DOMESTIC POLITICS VS. INTERNATIONAL PRESSURE

This paper presents an intertemporal political economy model of public finance relevant for developing and transition countries where there is inherent political instability. As in Cukierman et al. (1992) , it is shown that political instability causes myopic behaviour by a rational government resulting in high levels of revenue from seigniorage. It is then argued that inflationary finance also increases barter and currency substitution, but if the government tries to suppress them, seigniorage taxation rises even more. Only international financial pressure can help eliminate the inflationary finance trap, but becomes less effective as the instability increases.     

Fiscal Consequences of Monetary Integration within a Common Economic Area: The Case of Belarus,Kazakhstan and Russia

This article analyses the possible impact of planned monetary integration on public sector revenue from seigniorage in Belarus, Kazakhstan and Russia. Using the concept of total gross seigniorage, we investigate the main sources and uses of the central bank revenue in these countries. Special attention is given to the role of seigniorage revenue in financing public sector expenditure. Amounts of yearly transfers from central banks to the state budget in Belarus, Kazakhstan and Russia are evaluated, and the size of potential gains and losses in seigniorage revenue under different scenarios of monetary integration are estimated.     

Debt,seigniorage, and the Growth Laffer Curve in developing countries

The endogenous growth literature established the existence of an inverted-U curve between taxes and economic growth, namely a Growth Laffer Curve, but empirical evidence on this relationship in developing countries is rather limited. Given that seigniorage and public debt are also important means of financing public spending in these countries, we take into account in this paper their respective impacts on growth, as they might deform the existing relationship between taxes and growth. To this end, we develop a growth model with public investment as the engine of perpetual growth, and look for the effect of debt, tax and money financing on economic growth. We study in particular the way fiscal and monetary policies deform the Growth Laffer Curve in developing countries. An empirical section based on a panel of 100 developing countries over the period 1980–2010 provides both OLS-Fixed Effects and GMM-system estimations that support our theoretical conclusions, namely the existence of Growth Laffer Curves indexed by the levels of debt and of seigniorage.     

Government Bond Seigniorage

Recent studies have indicated that government bonds are an imperfect substitute for money in providing transaction services. Based on these studies, this article develops a theoretical framework showing that, as with money seigniorage, the government can gain an interest benefit from issuing government bonds. The article terms this interest benefit as ‘government bond seigniorage’. Further, the article estimates government bond seigniorage in comparison with money seigniorage for five countries (Australia, Canada, France, Italy and the United States) during the period 1959–2001. It is found that government bond seigniorage accounts for a larger percentage of Gross Domestic Product than money seigniorage, but also experiences greater fluctuations for all sample countries.     

Financial development,institutional quality and maximizing-growth trade-off in government finance

This paper studies monetary and fiscal policies in an endogenous growth model with transaction costs. We show that the relation between long-run economic growth and both monetary and fiscal policies is subject to threshold effects, a result that gives account of a number of recent empirical findings. Furthermore, the model shows that, to finance public expenditures, growth-maximizing governments must choose relatively high seigniorage (respectively income taxation), if “institutional quality” and “financial development” indicators are low (respectively high). Thus, our model may explain why some governments resort to seigniorage and inflationary finance, and others rather resort to high tax rates, as a result of growth-maximizing strategies in different structural environments (notably concerning institutional and financial development contexts). In addition, the model allows examining how the optimal mix of government finance changes in response to different public debt contexts. A short empirical section confirms our theoretical results.     

Political instablility and seigniorage: An inseparable couple — or a threesome with debt?

In the literature, political instability is shown to raise seigniorage and/or debt, but there is no debt‐seigniorage trade‐off. However, what happens when the IMF gets involved? Based on a political economy model of intertemporal public finance this paper presents qualitatively new and robust results. First, political instability causes myopic government behaviour and produces more debt, not more seigniorage. Second, IMF policies requiring debtor countries to achieve both monetary and fiscal stability at the same time are ineffective. Third and surprisingly at first sight, debt conditionality aiming at monetary stability is particularly effective in heterogeneous societies with unstable governments.     

Government financing in an endogenous growth model with financial market restrictions

Summary. In this paper, we develop an endogenous growth model with market regulations on explicitly modeled financial intermediaries to examine the effects of alternative government financing schemes on growth, inflation, and welfare. In the presence of binding regulation, there is always a unique equilibrium. We perform four alternative policy experiments; a change in the seigniorage tax rate, a change in the seigniorage tax base, a change in the income tax and a change in the fiscal-monetary policy mix. We find that in the presence of binding legal reserve requirements, a marginal increase in government spending need not result in a reduction in the rate of economic growth if it is financed with an increase in the seigniorage tax rate. Raising the seigniorage tax base by means of an increase in the reserve requirement retards growth and it has an ambiguous effect on inflation. An increase in income tax financed government spending also suppresses growth and raises inflation although not to the extent that the required seigniorage tax rate alternative would. Switching from seigniorage to income taxation as a source of government finance is growth reducing but deflationary. From a welfare perspective, the least distortionary way of financing an increase in the government spending requirements is by means of a marginal increase in the seigniorage tax rate. Under the specification of logarithmic preferences, the optimal tax structure is indeterminate. Received: March 20, 2000; revised version: June 26, 2001     

Monetary union in West Africa: who might gain,who might lose,and why?

Abstract.  We develop a model in which governments' financing needs exceed the socially optimal level because public resources are diverted to serve the narrow interests of the group in power. From a social welfare perspective, this results in undue pressure on the central bank to extract seigniorage. Monetary policy also suffers from an expansive bias, owing to the authorities' inability to precommit to price stability. Such a conjecture about the fiscal‐monetary policy mix appears quite relevant in Africa, with deep implications for the incentives of fiscally heterogeneous countries to form a currency union. We calibrate the model to data for West Africa and use it to assess proposed ECOWAS monetary unions. Fiscal heterogeneity indeed appears critical in shaping regional currency blocs that would be mutually beneficial for all their members. In particular, Nigeria's membership in the configurations currently envisaged would not be in the interests of other ECOWAS countries unless it were accompanied by effective containment on Nigeria's financing needs. JEL classification: E58, E61, E62, F33     

Seigniorage Wealth and Redistribution in Central and Eastern European Countries

The analysis presented in this article focuses on seigniorage revenues in five Central and Eastern European Countries: Bulgaria, the Czech Republic, Hungary, Poland and Romania. A comprehensive discrete period accounting framework for measuring the sources and uses of seigniorage in the 1990s is presented. The framework is based upon the gross concept of seigniorage that defines seigniorage in the broadest possible sense as the sum of revenues resulting from the monopoly power to issue money. Legal, institutional and operational details which are relevant for the creation of base money in a country are taken into account. The article reveals similarities and differences in seigniorage wealth between the countries under scrutiny, evaluates the magnitude of seigniorage and shows that accession to the European Monetary Union will create significant once-and-for-all gains of seigniorage wealth for the countries resulting from redistributing seigniorage wealth.     

SEIGNIORAGE, DOMESTIC DEBT, AND FINANCIAL REFORM IN CHINA

This paper describes the institutional features of China's hybrid economy that have allowed the government to earn high levels of seigniorage. It quantifies both the financial benefits and implicit costs to the government of extracting seigniorage from the economy. The analysis, which is based on the inside/outside money model of Gurley and Shaw (1960), indicates that seigniorage earnings in the period 1987—1994 were large, but were earned at the cost of a rising implicit government debt and potential future inflation. The paper also outlines how the Chinese government's ability to earn seigniorage in the future may decline as the economy becomes fully monetized and as reform alters the economy's unique institutional structure.     

Fiscal transparency, political parties, and debt in OECD countries

Many believe and argue that fiscal, or budgetary, transparency has large, positive effects on fiscal performance. However, the evidence linking transparency and fiscal policy outcomes is less compelling. To analyze the effects of fiscal transparency on public debt accumulation, we present a career-concerns model with political parties. This allows us to integrate as implications of a single model three hitherto-separate results in the literature on deficit and debt accumulation: that transparency decreases debt accumulation (at least by reducing an electoral cycle in deficits), that right-wing governments (at least for strategic reasons) tend to have higher deficits than left-wing governments, and that increasing political polarization increases debt accumulation. To test the predictions of the model, we construct a replicable index of fiscal transparency on 19-country OECD data. Simultaneous estimates of debt and transparency strongly confirm that a higher degree of fiscal transparency is associated with lower public debt and deficits, independent of controls for explanatory variables from other approaches.     

Institutional foundations of export diversification patterns in oil-producing countries

While it is well known that resource exporting countries have higher export concentration, it is lesser known that there is substantial variance in export concentration fortunes within resource-based countries. Using several estimation techniques and other sensitivity checks, this paper offers a new explanation for success and failure in export diversification patterns in oil countries, an explanation which has an institutional and political background. In measuring the number of years between the beginning of oil production and the attainment of political independence in oil developing countries, we found that the greater the number of years, the higher the degree of export diversification ceteris paribus. Our interpretation of this result is grounded in an analysis of political constraints to diversification in resource-based countries. Institutions, unfavorable to diversification, which arose from the pre-independence period, were blocked in their positive evolution by national political elites in the post-independence period. This result contributes to a better understanding of the dynamics of institutions in resource-based countries.     

The political economy of IMF conditionality and central bank independence

International organizations (IOs) often drive policy change in member countries. Given IOs' limited political leverage over a member country, previous research argues that IOs rely on a combination of hard pressures (i.e., conditionality) and soft pressures (i.e., socialization) to attain their political goals. Expanding this literature, we hypothesize that IOs can enhance their political leverage through loan conditions aimed at enhancing the political independence of key administrative units. Studying this mechanism in the context of the International Monetary Fund (IMF), we argue that through prescribing structural loan conditions on central banks (CBI conditionality), the IMF empowers central banks to gain more political leverage with the aim to limit a government's ability to (ab)use monetary policy for political gain. Divorcing monetary authorities from their respective government, the IMF intends to alter political dynamics towards achieving greater program compliance and enhance long-term macro-financial stability. Relying on a dataset including up to 124 countries between 1980 and 2012, we find that the IMF deploys CBI conditionality to countries with fewer checks and balances, a less independent central bank, and where the government relies more heavily on the monetization of public debt.     

Seigniorage and EMU : The fiscal implications of price stability and financial market integration

Disinflation, especially if coupled with financial market liberalisation, has implications for public finances because it lowers the revenue from the inflation tax. There might thus be a trade-off between the criteria on inflation convergence and public finances that were set at Maastricht. This paper measures the effects of lower inflation and financial market integration on the revenue from seigniorage for the EC member countries that have in the past relied most heavily on this source of revenues. The main result is that disinflation alone will reduce the revenue from seigniorage by over 2% of GDP in Greece, but much less than 1% of GDP in the other countries considered here. The overall impact of EMU (i.e. disinflation plus financial market integration) is a loss of seigniorage revenues of 2.9% of GDP in Greece and a little over 1% of GDP in Portugal and Spain. Two different measures of seigniorage yield similar results regarding the overall change, but differ regarding the transitional period and the level.     

Variation in the fiscal multiplier with the method of financing: evidence across industrial countries

Government spending has often varied with the business cycle to stimulate the economy and to revive economic conditions. However, the state of public finances has often necessitated higher borrowing to finance widening fiscal deficits. Indeed, recent austerity packages around the globe have crystalized the importance of fiscal consolidation against the backdrop of rising public debt. To shed light on recent debates regarding fiscal multipliers, the article estimates variation in these multipliers with the method of financing, using annual data for a sample of industrial countries. There is a large variation in the effects of expansionary and contractinary government spending shocks on economic variables within and across countries. The significant effects of negative government spending shocks (fiscal contraction) appear more prevalent than those of expansionary shocks on real output growth, price inflation and nominal wage inflation. Consistent with theory’s predictions, the fiscal multiplier is more likely to be negative when government spending is financed by issuing debt and less likely in the case of monetization. The evidence confirms concerns about the negative effect of higher debt and more expensive financing on private activity, countering the effectiveness of fiscal policy.     

Growth volatility and the interaction between economic and political development

Research on the effect of democracy on economic growth has not reached a definitive conclusion. Yet, research on the effect of democracy on economic growth volatility has consistently found that higher levels of democracy reduce volatility. Similarly, research has found that higher levels of economic development retard volatility. Using a novel empirical approach, this article presents evidence of an interactive effect between higher levels of democratization and economic development on growth volatility. Specifically, the marginal effect of political development on volatility is negative until countries reach per capita income levels of about $2,700, depending on the conditioning set. The marginal effect is insignificant for countries with higher levels of income. This implies that at a minimum, nearly 50% of the countries in our sample could enjoy less volatile economies with greater political development.     

Budget deficits,money growth and inflation: the Turkish evidence

The paper investigates the long-run relationships between budget deficits, inflation and monetary growth in Turkey considering two alternative trivariate systems corresponding to the narrowest and the broadest monetary aggregates. While the joint endogeneity of money and inflation rejects the validity of the monetarist view, lack of a direct relationship between inflation and budget deficits makes the pure fiscal theory explanations illegitimate for the Turkish case. Consistent with the policy regime of financing domestic debt through the commercial banking system, budget deficits lead to a growth not of currency seigniorage but of broad money in Turkey. This mode of deficit financing, leading to the creation of near money and restricting the scope for an effective monetary policy, may not be sustainable, as the government securities/broad money ratio cannot grow without limit.     

International Reserves and Fiscal Policy in Developing Countries

This paper investigates empirically the relationship between the pattern of fiscal policy and the demand for international reserves in developing countries, and how this relationship is associated with political risk and conditional access to global capital markets. It finds evidence that for developing countries with low political risk, countercyclical (procyclical) fiscal policies are associated with higher (lower) international reserve holdings in economic downturns. The relationship is stronger when the countries with low political risk rely heavily on external financing. For developing countries with high political risk, the link between reserves holdings and fiscal policy pattern is not clear-cut.     

Delays of Inflation Stabilizations

In some new political economic models, delays of stabilizations result from coordination problems caused by collective choice-making mechanisms. Although several previous studies have tested the effects of political instability and fragmentation on seigniorage, deficits, or inflation, no direct tests of the influence of these factors on the delays of stabilizations have previously been undertaken. This paper reports the results of such tests. The degree of fragmentation of the political system and the level of inflation are identified as important determinants of the timing of inflation stabilizations.     

Optimal composition of government public capital financing

Most recent studies on growth models with public investment in infrastructure (public capital) presume that public capital is financed by income taxation. However, in the model where money is demanded for transactions, this paper finds that optimal public capital financing in general involves utilizing both income taxation and seigniorage. In such a case, the optimal income tax rate is less than the output elasticity of public capital, a reasonable result compared with empirical evidence.