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

This paper reviews some inflationary and growth claims surrounding fiscal and monetary policy interactions. We tie the fiscal and monetary policies via the government budget constraint in an endogenous growth model where financial intermediaries are explicitly modeled. A spatial separation version of an overlapping generation model where Diamond- Dybvig type liquidity shocks are present due to interlocation interactions is adopted to have financial intermediaries arise endogenously. We show that the relation between growth and inflation, as well as the existence and uniqueness of the balanced growth equilibrium, depends crucially on how financial intermediaries form their optimal portfolio. This in turn is determined by the agents' degree of relative risk aversion. The effects of different government financing methods, income taxation versus seigniorage, on economic growth and welfare are also investigated