Expansionary Fiscal Contraction: Government Spending Financed By Money Seigniorage

This paper determines the conditions required for fiscal contractions to be expansionary when government spending is financed by money seigniorage. It shows that the expansionary effects of permanent fiscal contractions are dependent on the initial rates of inflation prevailing in the economy and that the set of initial inflation rates under which fiscal contractions are expansionary is affected by the degree of substitutability between public and private consumption. Starting from the benchmark case where public and private consumption are independent, introducing complementarity between public and private consumption gives rise to a weaker set of conditions for fiscal contractions to be expansionary. This implies that economies that print money to finance government spending complementary with private consumption are more likely to experience expansions if they pursue fiscal contractions.