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Interest Rate Implications for Fiscal and Monetary Policies: A Postscript on the Government Budget Constraint

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  • Benjamin M. Friedman
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    Abstract

    An earlier paper by the author investigated the quantitative implications, for the effectiveness of fiscal and monetary policies, of a model treating the determination of long-term interest rates by explicitly imposing the market clearing equilibrium condition that the quantity of bonds issued by private borrowers equal the quantity purchased by lenders. One incomplete aspect of that investigation, however, was the failure to allow explicitly for the government budget constraint. This paper reports results based on an expanded model that also imposes an analogous market clearing condition in the U.S. government securities market. The explicit imposition of the government budget constraint makes a major difference for the simulated effectiveness of both fiscal and monetary policies -indeed, a greater difference than that due simply to using the supply-demand representation of the determination of the private bond rate in the earlier paper. As is to be expected on the basis of familiar economic theory, the effect of imposing the government budget constraint is to make the real-sector effects of fiscal policy appear smaller and the real- sector effects of monetary policy appear greater. The main message of these results is that, when relative asset stock effects are the heart of the issue -as is the case in analyzing the implications of the government budget constraint -models that are implicitly consistent with the relevant economic behavior are not the same as models that explicitly represent it.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0886.

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    Date of creation: Apr 1982
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    Publication status: published as Friedman, Benjamin M., "Interest Rate Implications for Fiscal and Monetary Policies: A Postscript on the Government Budget Constraint," Journal of Money, Credit, and Banking, Vol. 14, No. 3, August 1982, pp. 4 07-412.
    Handle: RePEc:nbr:nberwo:0886

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    1. Friedman, Benjamin M, 1978. "Who Puts the Inflation Premium into Nominal Interest Rates?," Journal of Finance, American Finance Association, American Finance Association, vol. 33(3), pages 833-45, June.
    2. Friedman, Benjamin M, 1980. "The Determination of Long-Term Interest Rates: Implications for Fiscal and Monetary Policies," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 12(2), pages 331-52, Special I.
    3. Benjamin M. Friedman, 1978. "Who Puts the Inflation Premium Into Nominal Interests Rates?," NBER Working Papers 0231, National Bureau of Economic Research, Inc.
    4. Benjamin M. Friedman, 1981. "Debt Management Policy, Interest Rates, and Economic Activity," NBER Working Papers 0830, National Bureau of Economic Research, Inc.
    5. Ando, Albert K, 1974. "Some Aspects of Stabilization Policies, the Monetarist Controversy, and the MPS Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(3), pages 541-71, October.
    6. Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, Elsevier, vol. 2(4), pages 319-337.
    7. Christ, Carl F, 1975. "Judging the Performance of Econometric Models of the U.S. Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 16(1), pages 54-74, February.
    8. V. Vance Roley, 1980. "A Disaggregated Structural Model of the Treasury Securities, Corporate Bond, and Equity Markets: Estimation and Simulation Results," NBER Technical Working Papers 0007, National Bureau of Economic Research, Inc.
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