Government Financing, Inflation, and the Financial Sector

INOVA Faculdade de Economia Working Paper Series No. 621

32 Pages Posted: 1 Mar 2018

See all articles by Bernardino Adao

Bernardino Adao

Bank of Portugal - Research Department

Andre C. Silva

Nova School of Business and Economics

Date Written: January 2018

Abstract

We calculate the effects of an increase in government spending financed with labor income taxes or inflation. We consider government spending in the form of government consumption or transfers. We use a model in which agents increase the use of financial services to avoid losses from inflation, as empirically the financial sector increases with inflation. The financial sector size is constant in standard cash-in-advance models, which implies optimal positive inflation. We reverse this result when we take into account the increase in the financial sector. In our framework, it is optimal to use taxes to finance the government. This result is robust to alternative specifications and definitions of seigniorage and government spending.

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 (January 2018). INOVA Faculdade de Economia Working Paper Series No. 621, Available at SSRN: https://ssrn.com/abstract=3126299 or http://dx.doi.org/10.2139/ssrn.3126299

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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