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Edward F. Buffie is Professor of Economics at Indiana University. He wishes to thank Peter Wickham for stimulating his interest in this topic when he visited the Research Department of the IMF and two anonymous referees and Robert Flood for constructive criticisms of earlier drafts of this article.
The analysis is based on small changes, so γ can be treated as constant and equation (1) yields the same solution for changes in the price level as the exact consumer price index.
The assumption ε < 1 is necessary to rule out perverse comparative-statics results and to ensure well-behaved dynamics. On the downward-sloping portion or the seigniorage Laffer curve, higher fiscal deficits are associated with lower inflation and the dynamics are indeterminate because an infinity of paths converge to the stationary equilibrium.
Sources are Ajayi (1997, Table 7) and Kenya Monthly Economic Review for Kenya and Moser, Rogers, and van Til (1997, Tables 5 and 6) for Nigeria.
Revenue from indirect taxes was 22.2 percent of consumption spending in 1992–93 (Central Bank of Kenya, 1998).
This measure is superior to total reserve money (line 14 in IMF, International Financial Statistics), since it does not include reserve money held by “other public entities.” (The inflation tax is levied on only the private sector.) The stock or high-powered money was unusually high (10.1 percent of GDP) in Kenya in 1992 because of extra spending before the elections. Much of the extra money was withdrawn through open-market sales in the first two months of 1993 (before the start of the tight-money episode).
I wish to thank Catherine Pattillo of the IMF for sending me the estimates for Nigeria and Kenya.
The solutions presented in the next section are elasticities with respect to μ. (nominal money growthl for small changes based on a linearized version of the model. This creates problems in tracking the term involving real interest payments in the government budget constraint. The true variation in the term rb is d(rb) = r1db + b1dr. The linearized approximation, however, is ρdb + b*dr, where b* is the new steady-state value of government debt. For small changes, b* = bο; but then both terms in the linear approximation are considerably smaller than in the true variation (rt, > r and bt, > bο). On June 30, 1993, four months into the tight-money program, the value of the internal debt was 31 percent of GNP. This figure is larger than bο but much less than b(t1)—the tight-money regime lasted another two months and real interest rates peaked in July. Thus, the solutions from the linearized model, where the debt is 31 percent of CW, certainly underestimate the adverse macroeconomic effects in the later stages of the tighl-moncy regime and probably in its earlier stages as well: b*dr > b1,dr until t > 0.25, but pdb < rtdb: and with forward-looking agents, underestimation of the future impact on inflation and the real interest rate results in underestimation of the impact in earlier periods.
This statement is a bit loose. Obviously money growth is permanently lower on equilibrium paths characterized by pleasant monetarist arithmetic. But slower money growth after t1 is guaranteed only if the government can precommit to a sufficiently long initial period of tight money.
The solutions for π and b are elasticities with respect to α, while those for r are semielasticities. When comparing results across tables, note that at the initial equilibrium a 10 percent reduction in α generates an equal 10 percent reduction in money growth. Ex post, however, the reduction in money growth will differ under the deficit-share and fixed-money-growth rules.