ELIMINATING THE INFLATIONARY FINANCE TRAP IN A POLITICALLY UNSTABLE COUNTRY: DOMESTIC POLITICS VS. INTERNATIONAL PRESSURE

Frank Bohn

Economics and Politics, 2006, vol. 18, issue 1, 71-94

Abstract: This paper presents an intertemporal political economy model of public finance relevant for developing and transition countries where there is inherent political instability. As in Cukierman et al. (1992), it is shown that political instability causes myopic behaviour by a rational government resulting in high levels of revenue from seigniorage. It is then argued that inflationary finance also increases barter and currency substitution, but if the government tries to suppress them, seigniorage taxation rises even more. Only international financial pressure can help eliminate the inflationary finance trap, but becomes less effective as the instability increases.

Date: 2006
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