Seigniorage, Taxation and Weak Government

Abstract

We examined a setting where decision making about financing a given amount of government spending is decentralized. Seigniorage is the residual tax that passively adjusts to meet the budget constraint. We place this budget making process in a repeated game setting and characterize the cooperative tax-seigniorage function. Three main results are 1) Seigniorage and transitory changes in output are positively correlated. This result holds after controlling for changes in government spending. 2) A positive (negative) covariation between current period government spending and transitory output strengthens (weakens) the positive relationship between seigniorage and transitory output. 3) Seigniorage is negatively correlated with trend output growth. Time series empirical tests using annual data for 20 OECD countries support the first two results. A test using cross-section data on 75 countries confirms the third hypothesis.

JEL Classification: H21, H23, E61, E62