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Can Public Spending Cuts be Inflationary?

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  • Buiter, Willem H.

Abstract

The paper uses a 'demand for seigniorage revenue' and 'supply of seigniorage revenue' approach to determine the consequences of cuts in public spending for the rate of inflation. Monetary financing is viewed as the residual financing mode, with tax rates and public debt/GDP ratios held constant. In a small open economy with an exogenous real interest rate, cuts in public consumption spending will lower the inflation rate in the revenue-efficient region of the seigniorage Laffer curve. When there are cuts in public sector capital formation, the inflation rate can rise even in the seigniorage-efficient region. This will be the case if the expenditure effect (which reduces the deficit one-for-one) is more than offset by direct and indirect revenue effects (which raise the deficit) and by the adverse money demand effect. When the real interest rate is endogenous, the scope for inflation-increasing public spending cuts in enhanced.

Suggested Citation

  • Buiter, Willem H., 1988. "Can Public Spending Cuts be Inflationary?," CEPR Discussion Papers 225, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:225
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    References listed on IDEAS

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    1. Willem H. Buiter, 1986. "Fiscal Prerequisites for a Viable Managed Exchange Rate Regime: A Non-technical Eclectic Introduction," NBER Working Papers 2041, National Bureau of Economic Research, Inc.
    2. Buiter, Willem H., 1987. "Borrowing to defend the exchange rate and the timing and magnitude of speculative attacks," Journal of International Economics, Elsevier, vol. 23(3-4), pages 221-239, November.
    3. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
    4. Blinder, Alan S, 1987. "Credit Rationing and Effective Supply Failures," Economic Journal, Royal Economic Society, vol. 97(386), pages 327-352, June.
    5. Buiter, Willem H, 1988. "Structural and Stabilization Aspects of Fiscal and Financial Policy in the Dependent Economy," Oxford Economic Papers, Oxford University Press, vol. 40(2), pages 220-245, June.
    6. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    7. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-325, August.
    8. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-680, May.
    9. Buiter, Willem H., 1977. "`Crowding out' and the effectiveness of fiscal policy," Journal of Public Economics, Elsevier, vol. 7(3), pages 309-328, June.
    10. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
    11. Buiter, Willem H, 1988. "Death, Birth, Productivity Growth and Debt Neutrality," Economic Journal, Royal Economic Society, vol. 98(391), pages 279-293, June.
    12. Feltenstein, Andrew & Morris, Stephen, 1988. "Fiscal stabilization and exchange rate instability," Policy Research Working Paper Series 74, The World Bank.
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    Cited by:

    1. Magazzino, Cosimo, 2011. "The nexus between public expenditure and inflation in the Mediterranean countries," MPRA Paper 28493, University Library of Munich, Germany.

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