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Monetary Capacity

Author

Listed:
  • Bonfatti, Roberto
  • Brzezinski, Adam
  • Karaman, Kivanç
  • Palma, Nuno Pedro G.

Abstract

Monetary capacity refers to a state's capacity to circulate money that is accepted by the public, whereas fiscal capacity refers to its capacity to tax. In this paper, we show both theoretically and empirically that monetary and fiscal capacity, and by extension, markets and states have a symbiotic relationship. On the theoretical front, we propose a model that establishes that a higher monetary capacity incentivizes the government to invest in the capacity to tax, because monetization eases taxation. Higher fiscal capacity, in turn, increases the public demand for money, because expected inflation is lower. On the empirical front, we find that monetary capacity had a significant and substantial causal impact on fiscal capacity. To identify this impact, we rely on a natural experiment, instrumenting the money stocks of England, France and Spain between 1550 and 1790 by the silver and gold output in the New World. Finally, to put our findings into a long-run perspective, we collect money stock and tax revenue data for European states from antiquity to the modern period, and document the close relationship between the two. These findings indicate that economic and political development cannot be understood independently. They also qualify the theory of the long-run neutrality of money: exogenous changes in money stock can and did have real long-run effects.

Suggested Citation

  • Bonfatti, Roberto & Brzezinski, Adam & Karaman, Kivanç & Palma, Nuno Pedro G., 2020. "Monetary Capacity," CEPR Discussion Papers 15299, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:15299
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    References listed on IDEAS

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    Cited by:

    1. Karaman, K. Kıvanç & Pamuk, Şevket & Yıldırım-Karaman, Seçil, 2020. "Money and monetary stability in Europe, 1300–1914," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 279-300.
    2. Nuno Palma, 2019. "American Precious Metals and their Consequences for Early Modern Europe," Working Papers 0174, European Historical Economics Society (EHES).

    More about this item

    Keywords

    fiscal capacity; inflation; monetary capacity; monetary non-neutrality; monetization; Quantity Theory of Money; taxation;

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • N10 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - General, International, or Comparative
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development

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