Fiscal and Monetary Policy Interactions in an Endogenous Growth Model With Financial Intermediaries

Abstract

This paper presents a framework that can help reconcile conflicting findings in the growth‐inflation literature. Here, the behavior of financial intermediaries plays a crucial role in the determination of the economy's inflation and real growth rates. Absent any restrictions on financial intermediation, there will be a unique equilibrium when agents are fairly risk averse. In this case, an increase in seigniorage‐financed government spending will always be inflationary and detrimental to growth. When agents exhibit a low degree of risk aversion, multiple equilibria emerge and a positive relation between inflation and growth à la Tobin can be observed.