Political Instability and Seigniorage: An Inseparable Couple — or a Threesome with Debt?

Abstract

In the literature, political instability is shown to raise seigniorage and/or debt, but there is no debt‐seigniorage trade‐off. However, what happens when the IMF gets involved? Based on a political economy model of intertemporal public finance this paper presents qualitatively new and robust results. First, political instability causes myopic government behaviour and produces more debt, not more seigniorage. Second, IMF policies requiring debtor countries to achieve both monetary and fiscal stability at the same time are ineffective. Third and surprisingly at first sight, debt conditionality aiming at monetary stability is particularly effective in heterogeneous societies with unstable governments.