Monetary Capacity

Roberto Bonfatti, Adam Brzezinski, K. Kivanc Karaman and Nuno Palma

Lewis Lab Working Papers Series from Arthur Lewis Lab, The University of Manchester

Abstract: Monetary capacity refers to the maximum level of monetization attainable by a state, given scarcity of commodity money and the need to finance public expenditure by taxing money. We develop a model showing that monetary and fiscal capacity are complements in imperfectly monetized economies. A positive shock to fiscal capacity implies lower expected seignorage and thereby increases monetary capacity. Simultaneously, a positive shock to monetary capacity increases the efficiency of taxation, 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). Our causal estimates indicate that increases in monetary capacity led to gradual and persistent increases in fiscal capacity in England, France and Spain. A historical overview of Europe and China from antiquity to the early-modern period confirms that monetary and fiscal capacity co-evolved in the long run.

Keywords: monetary capacity; fiscal capacity; monetization; inflation; taxation; quantity theory of money; monetary non-neutrality (search for similar items in EconPapers)
JEL-codes: E50 E60 H21 N10 O11 (search for similar items in EconPapers)
Date: 2025-01
New Economics Papers: this item is included in nep-cba, nep-fdg and nep-mon
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Related works:
Working Paper: Monetary Capacity (2020)
Working Paper: Monetary Capacity (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:man:allwps:0007

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