Part 2.

Financing Government
Purchases
 Several ways to finance government
expenditure:
Printing money (inflation tax)
Taxes
Issuing bonds.
Financing Government Purchases
Revenue from money creation: Seigniorage.
Value of money creation:

1
M t M t1 z 1M t1 1 M t
z
It can finance the governments acquisition of
1
Gt 1 t M t
z
Assumption: Government spending does not
affect an agents consumption bundle.

 Budget set
If population is constant, we get
N t 1y c1
t 1 M t 1 Mt 1

t N t y c1 M t 1 z
Mt
Given that the rate of return on money is (1/z),
the individuals lifetime budget constraint is

c1 z c 2 y
Consumption choice
 Does Seigniorage represent an
unlimited resource of government
revenue?
No, government revenue in terms of
real goods is limited by the real value of
the fiat money stock.
 Tax base vs tax rate
Revenue from seigniorage is
1
M t M t1 t 1 t M t
z

t Mt : the seigniorage tax base

1 - (1/z) : the seigniorage tax rate

As the tax rate increases, the tax base

shrinks.