Working Paper: CEPR ID: DP15299
Authors: Roberto Bonfatti; Adam Brzezinski; Kivan Karaman; Nuno Palma
Abstract: Monetary capacity refers to the maximum level of monetization attainable by a state, given the constraints that it faces. We develop a model showing that monetary and fiscal capacity are complements in imperfectly monetized economies. Higher fiscal capacity is associated with lower seignorage, and hence higher monetization. Simultaneously, higher monetization increases the value of the economy, and hence the incentive to invest in fiscal capacity. We take this model to the data by exploiting an exogenous shock to Europe’s monetary capacity: the inflow of precious metals from the Americas (1550-1790). Monetary and fiscal capacity both rose after these inflows, predating modern economic growth by several decades. Our causal estimates indicate that increases in monetary capacity led to gradual and persistent increases in fiscal capacity in England and France. A historical overview of Europe and China documents the co-evolution of monetary and fiscal capacity from antiquity to the early modern period.
Keywords: monetary capacity; fiscal capacity; monetization; inflation; taxation; quantity theory of money; monetary nonneutrality
JEL Codes: E50; E60; H21; N10; O11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal capacity (E62) | Public demand for money (E41) |
| Monetary capacity (E40) | Public demand for money (E41) |
| Monetary capacity (E40) | Fiscal capacity (E62) |
| Influx of precious metals (N11) | Monetary capacity (E40) |