Coordinating Restraint:Deimocratization, Fiscal Policy and Money Creation in Latin America

Abstract

Although previous studies have posited a link between new democracies and economic policy, theoretical justification for this hypothesis has been sketchy, while econometric tests have been lacking. This article explores the link between public finance and democratic age via the notion of “competitive externalities” and their effect upon monetary financing of expenditures (seignorage). The argument is that transitions to democratic rule heighten the challenge of coordinating fiscal decisionmaking in the short term by dispersing fiscal authority and reordering institutional relationships among policymakers. In the long term, asymmetries generated by elections and/or crises attenuate the external costs of democratization. This hypothesis is tested econometrically, using a timeseries cross-sectional analysis of monetary financing of deficits (seignorage) for ten Latin American countries, which shows that new democracies are indeed associated with a short-term bias toward seignorage.