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THE OPTIMAL PUBLIC EXPENDITURE FINANCING POLICY: DOES THE LEVEL OF ECONOMIC DEVELOPMENT MATTER?
Author(s) -
BOSE NILOY,
HOLMAN JILL A.,
NEANIDIS KYRIAKOS C.
Publication year - 2007
Publication title -
economic inquiry
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.823
H-Index - 72
eISSN - 1465-7295
pISSN - 0095-2583
DOI - 10.1111/j.1465-7295.2007.00021.x
Subject(s) - economics , seigniorage , inflation (cosmology) , capital expenditure , market liquidity , public expenditure , aggregate expenditure , monetary economics , developing country , public finance , macroeconomics , finance , monetary policy , economic growth , physics , theoretical physics
This paper explores how the optimal mode of public finance depends on the level of economic development. The theoretical analysis suggests that in the presence of capital market imperfection and liquidity shocks, the detrimental effect of inflation on growth is stronger (weaker) at lower (higher) levels of economic development. Consequently, income taxation (seigniorage) is a relatively less distortionary way of financing public expenditure for low‐income (high‐income) countries. We provide empirical support for our model’s predictions using a panel of 21 Organization for Economic Cooperation and Development countries and 40 developing countries observed over the period 1972–1999. ( JEL E44, E6, H6, O42)