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Government Financing in an Endogenous Growth Model with Financial Market Restrictions

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  • Marco Espinosa
  • Chong K. Yip

Abstract

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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Suggested Citation

  • Marco Espinosa & Chong K. Yip, 2000. "Government Financing in an Endogenous Growth Model with Financial Market Restrictions," Departmental Working Papers _118, Chinese University of Hong Kong, Department of Economics.
  • Handle: RePEc:chk:cuhked:_118
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    References listed on IDEAS

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    1. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-1037, October.
    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 771-791, November.
    3. Wang, Ping, 1993. "Money, competitive efficiency, and intergenerational transactions," Journal of Monetary Economics, Elsevier, pages 303-320.
    4. 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 235-252, May.
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    Citations

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    Cited by:

    1. Beatrix Paal & Bruce D. Smith, 2013. "The sub-optimality of the Friedman rule and the optimum quantity of money," Annals of Economics and Finance, Society for AEF, vol. 14(2), pages 911-948, November.
    2. Holman, Jill A. & Neanidis, Kyriakos C., 2006. "Financing government expenditures in an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1315-1337, August.
    3. Lu, Chia-Hui & Chen, Been-Lon & Hsu, Mei, 2011. "The dynamic welfare cost of seignorage tax and consumption tax in a neoclassical growth model with a cash-in-advance constraint," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 247-258, June.
    4. Niloy Bose & Jill A. Holman & Kyriakos C. Neanidis, 2007. "The Optimal Public Expenditure Financing Policy: Does The Level Of Economic Development Matter?," Economic Inquiry, Western Economic Association International, vol. 45(3), pages 433-452, July.
    5. repec:bpj:bejmac:v:17:y:2017:i:2:p:24:n:7 is not listed on IDEAS
    6. Ghosh Sugata & Neanidis Kyriakos C., 2017. "Corruption, fiscal policy, and growth: a unified approach," The B.E. Journal of Macroeconomics, De Gruyter, pages 1-24.
    7. Barnett, Richard C., 2005. "Coordinating macroeconomic policy in a simple AK growth model," Journal of Macroeconomics, Elsevier, pages 621-647.
    8. Hung, Fu-Sheng, 2005. "Optimal composition of government public capital financing," Journal of Macroeconomics, Elsevier, vol. 27(4), pages 704-723, December.
    9. Patrick Honohan, 2003. "Taxation of Financial Intermediation : Theory and Practice for Emerging Economines," World Bank Publications, The World Bank, number 15122.
    10. Keith Blackburn & Kyriakos C. Neanidis & M. Emranul Haque, 2008. "Corruption, Seigniorage and Growth: Theory and Evidence," CESifo Working Paper Series 2354, CESifo Group Munich.

    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • O42 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Monetary Growth Models

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