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Can Public Spending Cuts be Inflationary?

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  • Buiter, Willem H

Abstract

The paper uses a 'demand for seigniorage revenue' and 'supply of seigniorage revenue' approach to determine the consequences of cuts in public spending for the rate of inflation. Monetary financing is viewed as the residual financing mode, with tax rates and public debt/GDP ratios held constant. In a small open economy with an exogenous real interest rate, cuts in public consumption spending will lower the inflation rate in the revenue-efficient region of the seigniorage Laffer curve. When there are cuts in public sector capital formation, the inflation rate can rise even in the seigniorage-efficient region. This will be the case if the expenditure effect (which reduces the deficit one-for-one) is more than offset by direct and indirect revenue effects (which raise the deficit) and by the adverse money demand effect. When the real interest rate is endogenous, the scope for inflation-increasing public spending cuts in enhanced.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 225.

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Date of creation: Apr 1988
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Handle: RePEc:cpr:ceprdp:225

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Keywords: Budget Deficit; Inflation; Laffer Curve; Public Sector Investment; Public Spending; Seigniorage;

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References

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  1. Buiter, Willem H, 1986. "Structural and Stabilization Aspects of Fiscal and Financial Policy in the Dependent Economy," CEPR Discussion Papers 128, C.E.P.R. Discussion Papers.
  2. Willem H. Buiter, 1984. "Saddlepoint Problems in Contifuous Time Rational Expectations Models: A General Method and Some Macroeconomic Ehamples," NBER Technical Working Papers 0020, National Bureau of Economic Research, Inc.
  3. Alan S. Blinder, 1985. "Credit Rationing and Effective Supply Failures," NBER Working Papers 1619, National Bureau of Economic Research, Inc.
  4. Buiter, Willem H, 1986. "Borrowing to Defend the Exchange Rate and the Timing and Magnitude of Speculative Attacks," CEPR Discussion Papers 95, C.E.P.R. Discussion Papers.
  5. Buiter, Willem H, 1988. "Death, Birth, Productivity Growth and Debt Neutrality," Economic Journal, Royal Economic Society, vol. 98(391), pages 279-93, June.
  6. Feltenstein, Andrew & Morris, Stephen, 1988. "Fiscal stabilization and exchange rate instability," Policy Research Working Paper Series 74, The World Bank.
  7. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  8. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  9. Maurice Obstfeld, 1986. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc.
  10. Buiter, Willem H., 1977. "`Crowding out' and the effectiveness of fiscal policy," Journal of Public Economics, Elsevier, vol. 7(3), pages 309-328, June.
  11. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
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Cited by:
  1. Magazzino, Cosimo, 2011. "The nexus between public expenditure and inflation in the Mediterranean countries," MPRA Paper 28493, University Library of Munich, Germany.

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