Virtual deficits and the Patinkin effect

The paper develops a model of inflationary finance that defines the fiscal deficit as a function of the virtual deficit-one that would be observed at zero inflation. It studies the negative relationship between the inflation Fate and peal government Expenditures-the Patinkin effect-a powerful stabil izer during megainflation. The model outperforms other seigniorage models i n explaining the persistence of four-digit inflation rates that never explo de into mt open hyperinflation. It also explains how apparently expansionis t fiscal policies end in measured real deficits that are small and compatib le with the small amount of seigniorage that carl be collected at high infl ation rates. [JEL E10, E31, E58, E62].