Government Financing, Inflation, and the Financial Sector.- Bernardino Adão, André C. Silva

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  • Last update: 22 March 2018
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  • Author: Bernardino Adão, André C. Silva


We calculate the effects of an increase in government spending financed with labor
income taxes or inflation. We consider government spending in the form of government
consumption or transfers. We use a model in which agents increase the use of financial
services to avoid losses from inflation, as empirically the financial sector increases with
inflation. The financial sector size is constant in standard cash-in-advance models, which
implies optimal positive inflation. We reverse this result when we take into account the
increase in the financial sector. In our framework, it is optimal to use taxes to finance the
government. This result is robust to alternative specifications and definitions of seigniorage
and government spending.

Keywords: fiscal policy, monetary policy, government financing, demand for money, financial sector