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Government Financing in an Endogenous Growth Model with Financial Market Restrictions

  • Marco Espinosa
  • Chong K. Yip

In this paper, we develop an endogenous growth model with market regulations on explicitly modeled financial intermediaries to examine the effects of alternative government financing schemes on growth, inflation, and welfare. In the presence of binding regulation, there is always a unique equilibrium. We perform four alternative policy experiments; a change in the seigniorage tax rate, a change in the seigniorage tax base, a change in the income tax and a change in the fiscal-monetary policy mix. We find that in the presence of binding legal reserve requirements, a marginal increase in government spending need not result in a reduction in the rate of economic growth if it is financed with an increase in the seigniorage tax rate. Raising the seigniorage tax base by means of an increase in the reserve requirement retards growth and it has an ambiguous effect on inflation. An increase in income tax financed government spending also suppresses growth and raises inflation although not to the extent that the required seigniorage tax rate alternative would. Switching from seigniorage to income taxation as a source of government finance is growth reducing but deflationary. From a welfare perspective, the least distortionary way of financing an increase in the government spending requirements is by means of a marginal increase in the seigniorage tax rate. Under the specification of logarithmic preferences, the optimal tax structure is indeterminate.

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Paper provided by Chinese University of Hong Kong, Department of Economics in its series Departmental Working Papers with number _118.

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Date of creation: May 2000
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Handle: RePEc:chk:cuhked:_118
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  1. Wang, Ping, 1993. "Money, competitive efficiency, and intergenerational transactions," Journal of Monetary Economics, Elsevier, vol. 32(2), pages 303-320, November.
  2. van der Ploeg, Frederick & Alogoskoufis, George S, 1994. "Money and Endogenous Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 771-91, November.
  3. Turnovsky, Stephen J, 1992. "Alternative Forms of Government Expenditure Financing: A Comparative Welfare Analysis," Economica, London School of Economics and Political Science, vol. 59(234), pages 235-52, May.
  4. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
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