Working Paper: NBER ID: w0566
Authors: Carl E. Walsh
Abstract: The standard result in macroeconomic models is that an increase in the stock of government debt has an ambiguous effect on aggregate demand. Models which have derived this result have assumed that all assets are gross substitutes. Some recent work within the framework of mean-variance portfolio models, however, seems to imply that the assumption that all assets are gross substitutes is sufficient to determine whether an increase in government debt is expansionary or contractionary. This apparent inconsistency is resolved by showing that gross substitutability is sufficient to sign the impact of a change in government debt only when money is riskless. To carry out the analysis, portfolio choice and equilibrium asset prices are characterized in a new way through the use of a distance function.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in government debt (H63) | ambiguous effect on asset prices (G19) |
| increase in government debt (H63) | determined impact on asset prices (if money is riskless) (G19) |
| increase in government debt (H63) | unclear impact on asset prices (if money involves risk) (G19) |
| sign of change in asset prices (G19) | cannot be determined by sign of covariance with government debt (H69) |
| assumptions about asset substitutability (G19) | influence causal claims between government debt and asset prices (H63) |