 |
Government
Budgetary Policies, Economic Growth and Currency
|
Abstract This paper compares the macroeconomic consequences of alternative government budgetary
policies in a small open economy where agents transact in both domestic and foreign
currencies. An endogenous growth model is used to rank the effects of income-tax-financed
and inflation-tax-financed government expenditures on the economy’s growth and
inflation rates. Currency substitution provides an avenue for inflation-tax evasion and
affects the rankings of the two modes of government finance. The analysis reveals that an
increase in the size of government reduces the growth rate of the economy regardless of
the government’s budgetary policy. Inflation taxes hinder growth more than income
taxes. Income-tax financing is also the preferred policy in terms of its effect on the
economy’s inflation rate. Under the growth-maximizing tax mix, the government relies
on both forms of finance but receives most of its revenue from income taxes. Jill A. Holman is an economist at the Federal Reserve Bank of Kansas City. The views expressed herein are solely those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.Holman E-mail: jill.a.holman@kc.frb.orgBack to top RWP home |