Political Parties and Optimum Government Financing: Empirical Evidence for Industrialized Economies

Abstract

Mankiw [12] argues that governments should equate the marginal losses of both taxation and seigniorage revenues to finance their spending. His model-the revenue smoothing hypothesisimplies that governments' tax and seigniorage revenues must move together. However, different types of political parties might be more concerned about creating seigniorage. The partisan theory argues that right-wing parties adopt less inflationary policies than left-wing parties. This theory assumes that there is a short term exploitable relationship between inflation and output growth, as the Phillips curve suggests. The theory also assumes that left-wing parties are more concerned with the unemployment rate than are right-wing parties. Therefore, to decrease the unemployment rate, left-wing administrations adopt more expansionary policies at the expense of higher levels of inflation [1; 3; 4; 7]. Furthermore, Burdekin [6] notes that countries which have a fixed exchange rate regime may face additional costs as they increase their seigniorage revenues. Increasing seigniorage revenue, which causes inflation, worsens the balance of payment deficit. This paper analyzes the optimal government financing under different types of political and institutional considerations, and argues that when governments must create additional resources to finance their spending, they will then use both their seigniorage and tax revenues simultaneously. Moreover, it incorporates the idea that right-wing governments and countries which have a fixed exchange rate regime are more reluctant to create seigniorage revenue than left-wing governments or countries which have a flexible exchange rate regime to finance their spending. The revenue smoothing hypothesis assumes that a government uses its monetary policy to create resources to finance its spending. However, such a government also uses its monetary policy to decrease the effects of business cycles and the variation of interest rates [9]. Barro and Gordon [5] show that a government may increase the levels of employment and of the GNP by increasing the money supply. Cukierman [8] argues that a government is concerned with the stability of financial markets. A government may increase its money supply to decrease the interest rates when they are too high, so that the financial system's likelihood of collapse will decrease. Later in this paper, the implication of the revenue smoothing hypothesis with the partisan and