Working Paper: CEPR ID: DP225
Authors: Willem H. Buiter
Abstract: The paper uses a 'demand for seigniorage revenue' and 'supply of seigniorage revenue' approach to determine the consequences of cuts in public spending for the rate of inflation. Monetary financing is viewed as the residual financing mode, with tax rates and public debt/GDP ratios held constant. In a small open economy with an exogenous real interest rate, cuts in public consumption spending will lower the inflation rate in the revenue-efficient region of the seigniorage Laffer curve. When there are cuts in public sector capital formation, the inflation rate can rise even in the seigniorage-efficient region. This will be the case if the expenditure effect (which reduces the deficit one-for-one) is more than offset by direct and indirect revenue effects (which raise the deficit) and by the adverse money demand effect. When the real interest rate is endogenous, the scope for inflation-increasing public spending cuts in enhanced.
Keywords: inflation; public sector deficit; public sector investment; seigniorage; Laffer curve
JEL Codes: 134; 310; 320
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cuts in public consumption spending (H69) | Lower inflation rate (E31) |
| Cuts in public consumption spending (H69) | Reduce public sector deficit (H69) |
| Reduce public sector deficit (H69) | Reduce demand for seigniorage revenue (E49) |
| Reduce demand for seigniorage revenue (E49) | Lower inflation rate (E31) |
| Cuts in public sector capital formation (H54) | Increase inflation rate (E31) |
| Cuts in public sector capital formation (H54) | Reduce public sector deficit (H69) |
| Reduce public sector deficit (H69) | Increase inflation rate (E31) |
| Cuts in public sector capital formation (H54) | Negative effect on money demand (E41) |
| Negative effect on money demand (E41) | Increase inflation rate (E31) |
| Real interest rate (exogenous) (E43) | Inflation outcomes of public spending cuts (E31) |
| Real interest rate (endogenous) (E43) | Inflation outcomes of public spending cuts (E31) |