ABSTRACT

The greater the separation between monetary and fiscal policies, the less likely governments will encroach on markets and the more likely that mercantile competition among them will enhance economic welfare. This can best be seen by examining, in historical perspective, how the changing conditions of money and credit in the United States influenced the capacity of different levels of government to borrow for current consumption. Beyond the American federalist experience, however, the principles involved are quite general. A federal system of government can, potentially, come closer to meeting Vito Tanzi’s criterion of separating monetary from fiscal policy than can a unitary state. But each level of government in the federal system must be fiscally independent. That is, each must have its own tax base that more or less matches its expenditure obligations without significant intergovernmental transfers.