The macroeconomic implications of deficit financing under present bias

Abstract

We examine how present bias affects deficit, inflation, and welfare in an economy where the deficit is funded by a seigniorage tax. In a hyperbolic discounting economy, reduced money holdings due to the desire for immediate consumption cause a decline in the sustainable deficit limit. To meet the targeted deficit, the government must raise seigniorage tax collection, especially with present bias. This results in increased inflation rates and higher welfare costs associated with the deficit for hyperbolic discounting individuals.