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Optimal Financing by Money and Taxes of Productive and Unproductive Government Spending: Effects on Economic Growth, Inflation, and Welfare

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  • David Alan Aschauer

    (The Jerome Levy Economics Institute)

Abstract

This paper contains an investigation of the effects of different means of financing government spending on economic growth, inflation, and welfare. In this setting, two different types of government spending are considered: productive expenditures which provide services to the private sector in its production activities; and unproductive expenditures which have no direct influence on the private economy. In turn, two different forms of finance are considered: proportional income taxation; and money creation. The primary result of the paper is, perhaps, striking in its simplicity. Specifically, we find that optimal public finance requires productive government to be financed by money creation and unproductive government expenditure by income taxation. Within the model structure–a representative agent, endogenous growth model with money introduced via a cash-in-advance constraint–the basic result is robust to changes in value of all underlying model parameters such as the intertemporal elasticity of substitution in consumption, the rate of time preference, and the output elasticity of public services. The paper proceeds as follows. Section II contains a brief description of the model. Section III presents the economic equilibrium, while Sections IV and V compare the effects of financing productive and unproductive expenditures, respectively, by taxation and money creation. Section VI brings together the previous sections considers the joint financing of government expenditures by taxation and money creation. Section VII concludes the paper and points to directions for future research.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 9808005.

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Length: 24 pages
Date of creation: 11 Aug 1998
Date of revision: 01 Sep 1998
Handle: RePEc:wpa:wuwpma:9808005

Note: Type of Document - Acrobat PDF; prepared on IBM PC - PC; to print on PostScript; pages: 24; figures: included
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Web page: http://128.118.178.162

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  1. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October.
  2. Robert J. Barro, 1998. "Determinants of Economic Growth: A Cross-Country Empirical Study," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522543.
  3. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
  4. Theodore Palivos & Chong K. Yip, 1995. "Government Expenditure Financing in an Endogenous Growth Model: A Comparison," Departmental Working Papers _057, Chinese University of Hong Kong, Department of Economics.
  5. Gerald P. Dwyer & R.W. Hafer, 1988. "Is money irrelevant?," Review, Federal Reserve Bank of St. Louis, issue May, pages 3-17.
  6. Turnovsky, Stephen J. & Fisher, Walter H., 1995. "The composition of government expenditure and its consequences for macroeconomic performance," Journal of Economic Dynamics and Control, Elsevier, vol. 19(4), pages 747-786, May.
  7. David Alan Aschauer, 2000. "Do states optimize? Public capital and economic growth," The Annals of Regional Science, Springer, vol. 34(3), pages 343-363.
  8. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
  9. N. Gregory Mankiw & David Romer & David N. Weil, 1992. "A Contribution to the Empirics of Economic Growth," NBER Working Papers 3541, National Bureau of Economic Research, Inc.
  10. Lynde, Catherine & Richmond, J, 1993. "Public Capital and Total Factor Productivity," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 401-14, May.
  11. Mary Finn, 1993. "Is all government capital productive?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 53-80.
  12. Evans, Paul & Karras, Georgios, 1994. "Are Government Activities Productive? Evidence from a Panel of U.S. States," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 1-11, February.
  13. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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