Academic journal article The Journal of Developing Areas

Optimal Seigniorage and Tax-Smoothing in West African Monetary Zone (Wamz): An Econometric Assessment

Academic journal article The Journal of Developing Areas

Optimal Seigniorage and Tax-Smoothing in West African Monetary Zone (Wamz): An Econometric Assessment

Article excerpt

ABSTRACT

The fiscal performance of many sub-Saharan African countries has been quite dismal over the past, with a number of them accumulating huge deficits. This paper examines fiscal sustainability in the West African Monetary Zone (WAMZ). It departs from the standard model of fiscal sustainability and adopts the optimal seigniorage and tax smoothing model. Using vector autoregressive model and data from two selected countries, Ghana and Nigeria, the study finds no concrete evidence in support of the optimal seigniorage and tax smoothing in WAMZ. The findings call for important fiscal reforms to reverse the persistent fiscal deficits. Such reforms should include measures to ensure compliance and eliminate fiscal corruptions

JEL Classification: H20; E52; E63; C30

Keywords: West Africa Monetary Zone (WAMZ), Tax Smoothing, Seigniorage, Optimal Monetary and Fiscal Policy, VAR.

Corresponding Author's Email Address: udoea@yahoo.com

INTRODUCTION

One of the main problems facing many countries in the developing world, and Africa in particular, is the lack of government funds to meet the amounting demand for public goods and services. The fiscal performance of many sub-Saharan African countries has been quite dismal over the past, with a number of them accumulating huge deficits. The major cause of large fiscal deficits has been rapid expansion in expenditure in the face of declining and unstable revenue. Fiscal authorities, therefore, are often confronted with the difficult task of choosing between expenditure cuts and raising revenue. This fiscal challenge has posed severe threats to progress towards the attainment of the global Millennium Development Goals (MDGs). However, many countries in the region have reduced expenditure to minimal levels, especially in health, education and social infrastructure, hence, further cuts in expenditure are not feasible. The difficulties often encountered in cutting expenditures call for other options, namely raising tax revenues or adopting what most people consider as the devil's alternative, Central Bank financing. However, financing government expenditure through seigniorage generated by the Central Bank is often considered a bad policy because it may result in hyperinflation with tremendous social and economic repercussions. It may discourage tax collection, investment and growth, thereby worsening poverty.

In view of the effects of inflation on the economy, it is naturally not expedient to rely heavily on policies that will encourage inflation.i Nonetheless, from the theory of optimal monetary and fiscal policy, there are some positive levels of inflation consistent with social welfare maximization (Blanchard and Fischer, 1989).ii It is therefore necessary to operate within the range of inflation rates that will yield optimal seigniorage revenue and ensure fiscal sustainability.

Building on an earlier argument by Phelps (1973), Mankiw (1987) developed the optimal seigniorage and tax smoothing model. This model argues that if a government uses both monetary and fiscal policies optimally, then, the two policy instruments will be cointegrated. The concept of tax smoothing implies that governments should run deficits in times of temporarily high public spending. Several empirical studies have been conducted to ascertain the validity of this proposition (Poterba and Rotemberg, 1990; Trehan and Walsh, 1990; Froyen and Waud, 1995; Ghosh, 1995; Evans and Amey, 1996). Findings of these studies so far are inconclusive, leaving the issue largely unresolved.

As pervasive as budget imbalances are in sub-Saharan Africa, few studies exist which seek to ask whether this outcome is consistent with any notion of optimal fiscal policy? The objective of this article is to examine the intertemporal and intratemporal behaviour of monetary and fiscal policies in the selected WAMZ member countries and their implications for government finance.

The results of the study contradicts the optimal seigniorage and tax smoothing theory, as no cointegration was found between the seigniorage revenue and tax revenue in the selected WAMZ member countries, namely, Ghana and Nigeria. …

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