Working Paper Number
WP #03012, October 2001 revised March 2003 revised March 2004; Old working paper #10252
Central banks typically find it difficult to turn off the "political pressure valve". This has important consequences for the types of monetary policies they implement. This paper presents an analysis of how political factors may come into play in the equilibrium determination of inflation. We employ a standard overlapping generations model with heterogeneous young-age endowments, and a government that funds an exogenous spending via a combination of nondistortionary income taxes and the inflation tax. Agents have access to two stores of value: fiat money and an inflation-shielded, yet costly, asset. The model predicts that the relationship between elected reliance on the inflation tax (for revenue) and income inequality is non-monotonic; in particular, the reliance on seigniorage may decrease as income inequality rises above a threshold. We find robust empirical backing for this hypothesis from a cross-section of countries.
Published in The Canadian Journal of Economics, Vol. 38 no. 2 (May 2005): 500-519.
E40, E5, P16
This version: March 2004 (First version: October 2001)
Bhattacharya, Joydeep; Bunzel, Helle; and Haslag, Joseph H., "The non-monotonic relationship between seigniorage and inequality" (2004). Economics Working Papers (2002–2016). 196.