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

  • Minea, Alexandru
  • Villieu, Patrick

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.

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Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 27 (2010)
Issue (Month): 1 (January)
Pages: 324-335

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Handle: RePEc:eee:ecmode:v:27:y:2010:i:1:p:324-335
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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  1. John H. Boyd & Ross Levine & Bruce D. Smith, 1997. "Inflation and financial market performance," Working Papers 573, Federal Reserve Bank of Minneapolis.
  2. Alexandru MINEA & Patrick VILLIEU, 2008. "Threshold Effects in Monetary and Fiscal Policies in a Growth Model : Assessing the Importance of the Financial System," LEO Working Papers / DR LEO 1666, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
  3. Ghosh, Sugata & Mourmouras, Iannis A., 2004. "Endogenous growth, welfare and budgetary regimes," Journal of Macroeconomics, Elsevier, vol. 26(4), pages 623-635, December.
  4. Ronald I. McKinnon, 1991. "Financial Control in the Transition from Classical Socialism to a Market Economy," Journal of Economic Perspectives, American Economic Association, vol. 5(4), pages 107-122, Fall.
  5. Gylfason, Thorvaldur, 1990. "Inflation, Growth and External Debt: A View of the Landscape," CEPR Discussion Papers 375, C.E.P.R. Discussion Papers.
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  7. Robert J. Barro & Xavier Sala-i-Martin, 1990. "Public Finance in Models of Economic Growth," NBER Working Papers 3362, National Bureau of Economic Research, Inc.
  8. Michael Bruno & William Easterly, 1995. "Inflation Crises and Long-Run Growth," NBER Working Papers 5209, National Bureau of Economic Research, Inc.
  9. Cukierman, Alex & Edwards, Sebastian & Tabellini, Guido, 1992. "Seigniorage and Political Instability," American Economic Review, American Economic Association, vol. 82(3), pages 537-55, June.
  10. Kneller, Richard & Bleaney, Michael F. & Gemmell, Norman, 1999. "Fiscal policy and growth: evidence from OECD countries," Journal of Public Economics, Elsevier, vol. 74(2), pages 171-190, November.
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  14. Bullard, James & Keating, John W., 1995. "The long-run relationship between inflation and output in postwar economies," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 477-496, December.
  15. Robert J. Barro, 1995. "Inflation and Economic Growth," NBER Working Papers 5326, National Bureau of Economic Research, Inc.
  16. Joseph H. Haslag & Jahyeong Koo, 1999. "Financial repression, financial development and economic growth," Working Papers 9902, Federal Reserve Bank of Dallas.
  17. 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.
  18. Roubini, Nouriel, 1991. "Economic and political determinants of budget deficits in developing countries," Journal of International Money and Finance, Elsevier, vol. 10(1, Supple), pages S49-S72, March.
  19. Anthony Philip Thirlwall & A.C. Barton, 1971. "Inflation and growth: the international evidence," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 24(98), pages 263-275.
  20. 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.
  21. Sebastian Edwards & Guido Tabellini, 1990. "Explaining Fiscal Policies and Inflation in Developing Countries," NBER Working Papers 3493, National Bureau of Economic Research, Inc.
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  24. Fischer, Stanley, 1979. "Capital Accumulation on the Transition Path in a Monetary Optimizing Model," Econometrica, Econometric Society, vol. 47(6), pages 1433-39, November.
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