Government Financing, Inflation, and the Financial Sector

50 Pages Posted: 15 Feb 2014 Last revised: 27 Mar 2020

See all articles by Bernardino Adao

Bernardino Adao

Bank of Portugal - Research Department

Andre C. Silva

Nova School of Business and Economics

Date Written: March 1, 2020

Abstract

We calculate the effects of an increase in government spending financed with labor income taxes or inflation. Government spending takes the form of government consumption or transfers. Agents increase the use of financial services to avoid losses from inflation. The financial sector increases with inflation, in accordance with the data. In standard cash-in-advance models, in the presence of government transfers, it is optimal to finance the government with inflation. In our framework, it is optimal to use taxes. We reverse the result from standard cash-in-advance models. The reason is the additional costs from the increase in the financial sector.

Keywords: fiscal policy, monetary policy, government financing, demand for money, financial sector

JEL Classification: E52, E62, E63

Suggested Citation

Adao, Bernardino and Silva, Andre C., Government Financing, Inflation, and the Financial Sector (March 1, 2020). Available at SSRN: https://ssrn.com/abstract=2395815 or http://dx.doi.org/10.2139/ssrn.2395815

Bernardino Adao

Bank of Portugal - Research Department ( email )

Av. Almirante Reis 71, 6th
Lisbon 1150-012
Portugal

Andre C. Silva (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Carcavelos, 2775-405
Portugal

HOME PAGE: http://sites.google.com/view/andredecastrosilva

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