Growth, integration, and macroeconomic policy design: Some lessons for Latin America

The paper examines government spending that is financed by taxes that distort output and by the inflation tax. High inflation and low output are the consequence of fiscal ambitions that exceed the current capacity of the economy to support. Supply-side growth alleviates this tension, allowing lower inflation, lower tax distortions, and higher output. In the presence of commitment problems, resolving only the problem of monetary commitment, but not commitment in fiscal policy and supply-side performance, may actually make things worse. Dollarization, when coupled with unresolved fiscal and supply-side commitment problems, may induce permanent stagnation. Unambiguous welfare improvement, therefore requires tackling all distortions simultaneously. The paper concludes by discussing the practical lessons that may be drawn from these principles for Latin America. © 2002 Elsevier Science Inc. All rights reserved. JEL classification: E42; E61; F41