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Can Public Spending Cuts be Inflationary?

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Author Info
Willem H. Buiter

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Abstract

The paper uses a demand for seigniorage revenue and supply of seigniorage revenue approach to determine the consequences 0 cots in public spending for the rate of inflation. Monetary financing is viewed as the residual financing mode, with tax rates and pubic debt-GDP ratios held constant. In a small open economy with an exogenous real interest rate, cuts n public consumption spending will lower the inflation rate n the revenue-efficient region of the seigniorage Laffer curve. When there are cuts in public sector capital formation , the inflation rate ran rise even in the seigniorage-efficient region. This sill 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 an adverse money demand effect. When the real interest rate is endogenous, the scope for inflation-increasing public spending cuts is enhanced.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2528.

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Date of creation: Feb 1988
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Handle: RePEc:nbr:nberwo:2528

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  1. 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. [Downloadable!] (restricted)
  2. Buiter, Willem H., 1987. "Borrowing to defend the exchange rate and the timing and magnitude of speculative attacks," Journal of International Economics, Elsevier, vol. 23(3-4), pages 221-239, November. [Downloadable!] (restricted)
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  3. Feltenstein, Andrew & Morris, Stephen, 1988. "Fiscal stabilization and exchange rate instability," Policy Research Working Paper Series 74, The World Bank. [Downloadable!]
  4. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  5. Maurice Obstfeld, 1986. "Rational and Self-Fulfilling Balance-of-Payments Crises," NBER Working Papers 1486, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. 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. [Downloadable!] (restricted)
  7. Blinder, Alan S, 1987. "Credit Rationing and Effective Supply Failures," Economic Journal, Royal Economic Society, vol. 97(386), pages 327-52, June. [Downloadable!] (restricted)
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  8. Buiter, Willem H., 1977. "`Crowding out' and the effectiveness of fiscal policy," Journal of Public Economics, Elsevier, vol. 7(3), pages 309-328, June. [Downloadable!] (restricted)
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