Fiscal Revenue, Inflationary Finance and GrowthThis paper analyzes the optimal rate of monetary expansion when government resorts to inflationary finance to generate additional investment for enhancing growth. If there are lags in tax collection, an increase in inflation erodes real fiscal revenue, thereby worsening the current balance while reducing government investment. This impedes capital accumulation as well as increases the welfare cost of inflation. As such, the optimal rate of monetary expansion, equilibrium capital-labor ratio and output are lower while the marginal cost of inflationary finance is higher than they would be without collection lags. Simulations are performed to highlight empirical implications. |
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adjustment analysis Appendix arbitrary number capital accumulation capital formation Choudhry coefficient of expected collection lags control problem cost of inflation effective consumption ratio effective saving maximizing effective saving ratio effects of inflation enhancing growth equation 15 equation 28 erosion of fiscal evidence on collection expected inflation fiscal deficit fiscal erosion fiscal revenue ratio government current growth objectives hyperinflation implying increasing the welfare inflation rate inflation revenue inflation tax inflationary finance level of fiscal levels of output lower marginal cost marginal welfare cost monetary expansion optimal rate output and consumption parameter values percent price of capital private consumption private saving rate rate of inflation rate of monetary rate of private real balance ratio real fiscal revenue reduction in real revenue maximizing rate scope of inflationary shadow price simulations social discount rate steady state capital-labor steady-state levels sustainable level tax system total revenue maximizing