Fiscal Policy and the Dynamics of Monetary Equilibrium

In the previous chapters government activity was given by a pair of parameters (g, τ) defining government consumption and a proportional tax rate on income, which were assumed to be constant over time. An important implication of such a stationary government policy was the observation that in each period the government’s deficit is endogenous and determined in size and sign at each temporary equilibrium. As a consequence, the amount of fiat money held by consumers as well as the deficit in each period is endogenous leading to explicit endogenous dynamics of the quantity of money induced by the equilibrium conditions on the two markets. In such cases, neither the sign or size of the deficit nor the change of the quantity of money is directly controlled by the government. Chapter 4 derived the major consequences of such policies showing that the two fisal parameters have a decisive influence on the existence, stability, and on the long-run real performance of the macroeconomy under rational expectations.