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Financial Development, Institutional Quality and Maximizing-Growth Trade-Off in Government Finance

Alexandru Minea () and Patrick Villieu ()

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Abstract: This paper studies monetary and fiscal policies in an endogenous growth model with transaction costs. We show that the relation between long-run economic growth and both monetary and fiscal policies is subject to threshold effects, a result that gives account of a number of recent empirical findings. Furthermore, the model shows that, to finance public expenditures, growth-maximizing governments must choose relatively high seigniorage (respectively income taxation), if "institutional quality" and "financial development" indicators are low (respectively high). Thus, our model may explain why some governments resort to seigniorage and inflationary finance, and others rather resort to high tax rates, as a result of growthmaximizing strategies in different structural environments (notably concerning institutional and financial development contexts). In addition, the model allows examining how the optimal mix of government finance changes in response to different public debt contexts. A short empirical section confirms our theoretical results.

Keywords: Endogenous growth; Threshold effects; Monetary policy; Fiscal policy; Public debt; Policy mix; Tax evasion; Financial repression; Financial development (search for similar items in EconPapers)
Date: 2010
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Published in Economic Modelling, Elsevier, 2010, 27 (1), pp.324-335

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Journal Article: Financial development, institutional quality and maximizing-growth trade-off in government finance (2010) Downloads
Working Paper: Financial Developpement, Institutional Quality and Maximizing-Growth Trade-off in Government Finance (2009) Downloads
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