Central Bank Independence, Fiscal Deficits, and the Poverty Trap

Abstract

This paper shows that multiple steady states occur if a central bank is not independent and is compelled to finance a large fiscal deficit through seigniorage. If the initial capital stock is less than a certain threshold, the economy converges to a steady state where the capital stock is low and the inflation rate is high. Tight fiscal policies bring the economy out of the poverty trap. Moreover, if the central bank is independent, the poverty trap is removed independently of the fiscal position.

Keywords: Central bank independence, Fiscal deficit, Poverty trap, Inflation, Seigniorage

JEL Classification: E63, O11, O23