Working Paper: NBER ID: w0905
Authors: Bennett T. McCallum
Abstract: This paper considers the possible theoretical validity of the following "monetarist hypothesis": that a constant, positive government budget deficit can be maintained permanently and without inflation if it is financed by the issue of bonds rather than money. The question is studied in a discrete-time, perfect-foresight version of the competitive equilibrium model of Sidrauski (1967), modified by the inclusion of government bonds as a third asset. It is shown that the monetarist hypothesis is invalid if the deficit is defined exclusive of interest payments, but is valid under the conventional definition. It is also shown that the stock of bonds can grow indefinitely at a rate in excess of the rate of output growth, provided that the difference is less than the rate of time preference. In addition to the main analysis, the paper includes comments on alternative deficit concepts, a brief consideration of data pertaining to the announced budget plans of the Reagan administration, and a new look at a much- studied issue: whether the operation of a Friedman-type constant money growth rule (with non-activist fiscal rules) would be dynamically feasible.
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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 |
|---|---|
| bond-financed deficit defined exclusive of interest payments (H68) | inflation (E31) |
| bond stock growth (G12) | inflation (E31) |
| bond-financed deficit defined to include interest payments (H74) | no inflation (E31) |
| growth rate of bond stock < rate of time preference (D15) | constant per capita deficit without inflation (H62) |
| Friedman-type money growth rule + constant government purchases + fixed tax schedule (E19) | dynamically unstable behavior of bond stock (G12) |