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On the Relevance or Irrelevance of Public Financial Policy

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  • Joseph E. Stiglitz

Abstract

This paper establishes conditions under which public financial policyhas neither real nor inflationary effects; under which it has inflationary effects, but not real effects; and under which it has real effects. An increase in government debt (keeping real expenditures fixed), accompanied by a decrease in lump sum taxes has neither inflationary nor real effects (even in astochastic environment) provided there are no redistribution effects: the increase in supply of government bonds gives rise to an exactly offsetting increase in demand. An increase in the interest rate paid on government debt will be associated with an increase in the rate of inflation, but there will be no real effects. A change in financial policy which preserves the mean rate of return on bonds has no real effects if individuals are risk neutral and changes in the level of debt are offset by changes in lump sum taxes/subsidies for the owners of bonds. Except in these special cases, changes in public financial policy will always have real effects.The second part of the paper establishes that the optimal intertemporal risk redistribution scheme can be implemented through financial policies which entail constant price levels. This result is established in the context of a life cycle model with homogeneous individuals. It is shown, furthermore,that only a single financial instrument is required to implement the optimal policy; additional financial instruments are redundant. This redundancy result does not obtain, however, with heterogeneous populations if there are restrictions on the ability of the government to impose differential lump sum taxes on different groups.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1057.

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Date of creation: Jan 1983
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Publication status: published as Arrow, Kenneth J. and Michael J. Boskin (eds.) The economics of public debt: Proceedings of a conference held by the International Economic Association at Stanford, California. New York: St. Martin's Press, 1988.
Handle: RePEc:nbr:nberwo:1057

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  1. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  2. K. Shell & M. Sidrauski & J. E. Stiglitz, 1967. "Capital Gains, Income, and Saving," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 12, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. John Bryant & Neil Wallace, 1980. "A suggestion for further simplifying the theory of money," Staff Report, Federal Reserve Bank of Minneapolis 62, Federal Reserve Bank of Minneapolis.
  4. Stiglitz, Joseph E, 1969. "A Re-Examination of the Modigliani-Miller Theorem," American Economic Review, American Economic Association, American Economic Association, vol. 59(5), pages 784-93, December.
  5. David Cass & Menahem E. Yaari, 1965. "Individual Saving, Aggregate Capital Accumulation, and Efficient Growth," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 198, Cowles Foundation for Research in Economics, Yale University.
  6. Joseph E. Stiglitz, 1972. "On the Irrelevance of Corporate Financial Policy," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 339, Cowles Foundation for Research in Economics, Yale University.
  7. Fischer, Stanley, 1979. "Anticipations and the Nonneutrality of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(2), pages 225-52, April.
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Cited by:
  1. Alan S. Blinder & Joseph E. Stiglitz, 1983. "Money, Credit Constraints, and Economic Activity," NBER Working Papers 1084, National Bureau of Economic Research, Inc.
  2. B. Douglas Bernheim, 1988. "Ricardian Equivalence: An Evaluation of Theory and Evidence," NBER Working Papers 2330, National Bureau of Economic Research, Inc.
  3. Bruce Greenwald & Joseph E. Stiglitz, 1987. "Money, Imperfect Information and Economic Fluctuations," NBER Working Papers 2188, National Bureau of Economic Research, Inc.
  4. Willem H. Buiter, 1983. "The Theory of Optimum Deficits and Debt," NBER Working Papers 1232, National Bureau of Economic Research, Inc.
  5. Michael J. Boskin, 1987. "Concepts and Measures of Federal Deficits and Debt and Their Impact on Economic Activity," NBER Working Papers 2332, National Bureau of Economic Research, Inc.
  6. Joseph H. Haslag & D.C. Betts, 1987. "Government debt, output, and asymmetric information," Working Papers, Federal Reserve Bank of St. Louis 1987-003, Federal Reserve Bank of St. Louis.

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