Ebook Financial Repression, Tax Evasion and Long-Run Monetary and Fiscal Policy Trade-Off in an Endogenous Growth Model with Transaction Costs
The impact of monetary and fiscal policies on long-run economic growth is an open issue of macroeconomic theory. Concerning monetary policy, most of standard “neoclassical” exogenous growth models conclude to some neutrality or “superneutrality” of money in steady-state (see Fischer, 1979), with the notable exception of Stockman (1981) cash-in-advance model, in which a money expansion reduces steady-state levels of capital and output, when (part of) investment expenditures are subject to the cash-in-advance (hereafter CIA) constraint. Concerning fiscal policy, results critically depends on the nature of government expenditures and on the way they are financed. Baxter & King (1993) introduce government consumption and public capital into the core Real Business Cycles model and show that increases in productive government spending can have very large effects on long run output because they increase the marginal product of private capital. However, this result is obtained on that assumption that these increases in productive government spending are financed by lump-sum taxes. Exploring different ways of government finance, Kamps (2004) shows that distorsionary taxes may discourage private investment, while there is trade off between short-run and long-run effects of deficit-financed increases in productive public spending.
However, these results only concern “neoclassical” models without endogenous growth in steady-state. Yet, establishing a relation between monetary and fiscal policies and long-run economic growth needs the use of endogenous growth models, which ensure the existence of a positive long-run economic growth path that can be affected by policy variables. Concerning fiscal policy, standard endogenous growth models show the existence of a threshold in the tax-rate to long-run economic growth relation, in link with the pioneer work of Barro (1990). In this model, productive public expenditures are financed by a flat tax rate on output. Increasing the tax rate implies a lower marginal net of taxes return of private capital, but since taxes finance public expenditures, which enhance private capital productivity, one can find a tax rate that maximizes economic growth in the long-run. This tax ceiling sums up the trade-off between the above mentioned conflicting effects.
Concerning monetary policy, most of theoretical results on endogenous growth models conclude that it is harmful or at best neutral, as in exogenous growth models. Empirical work is less conclusive. Barro (1995) shows that sustained high inflation rates, used as a proxy of expansionist monetary policies, are detrimental to long-run performance, but the robustness of this result is questioned by other studies (see, e.g. Levine & Renelt, 1992). Subsequent work seems to confirm the existence of a negative correlation between inflation and economic growth, but only for high-inflation countries (Bullard & Keating, 1995, Sarel, 1996,…), showing that the inflation to economic growth relation is nonlinear. In addition, a number of recent econometric results exhibit threshold effects of inflation on economic growth, confirming the nonlinear relation between monetary policy and long-run growth. However, as Boyd, Levine & Smith emphasizes, “the mechanism underlying this apparently nonlinear association remains to be unearthed” (1997, p.1) and this “epidemic of thresholds” in monetary policy seems not to have find its theoretical support.
Recent econometric studies have the merit of unifying the analysis of both monetary and fiscal policies. One interesting paper is Adam & Bevan (2005), who find strong empirical evidence on the existence of non-linearities in the effects of both fiscal deficits and seigniorage tax rates on economic growth. Unfortunately, economic theory does not provide, to our knowledge, any global model for studying the effect of the fiscal and monetary policy-mix on long-run economic growth, even if some papers deal with fiscal issues (see, for example, Greiner & Semmler, 2000, Ghosh & Mourmouras, 2004), or monetary ones (Palivos & Yip, 1996). Therefore, the aim of this paper is to analyze the impact of different economic policies (money creation, tax policy, public spending and public debt) on long-run economic growth in a global framework.
In our model, interactions between monetary and fiscal policies principally occur by the channel of the government budget constraint. To model monetary and fiscal policies in the simplest way, we start with Barro (1990) endogenous growth model with productive public spending. In this model, we introduce a non trivial government budget constraint, in order to study the effect of alternative ways of government finance on long-run economic growth. In our model, government takes a flat tax-rate from households’ income, but also collects revenues from central bank money creation (seigniorage) and can borrow from households, generalizing the Barro government budget constraint where only taxes are allowed. In addition, we assume that part of tax revenues is subject to “tax evasion” (or collecting cost). Similarly to this “tax flight”, we distinguish between central bank seigniorage (which is transferred to government) and private seigniorage (which is transferred to households). Effectively, in countries with developed financial systems, most of the seigniorage is retrieved by the banking system, and constitutes a “seigniorage flight” for the central bank. On the contrary, in financial repressed economies, most of the seigniorage is collected by the central bank and can be used for government finance.
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