Policy rules, information and fiscal effects in a "Ricardian" model
According to conventional wisdom, if deficits are inflationary then current deficits should predict subsequent movements in money growth. This paper USES a general equilibrium model fit to data to: (1) explore the policy behavior underlying this accepted viewpoint; (2) examine alternative equilibrium deficit policies ranging from an exclusive reliance on direct lump-sum taxes to a mix of direct and inflation taxes; and (3) evaluate the empirical trade-offs implied by the various financing schemes. The results suggest that reduced-form analyses of whether "deficits matter" can lead to seriously misleading conclusions by mistakenly attributing fiscal effects to monetary policy. ; I demonstrate that simple monetary and tax policy rules and plausible assumptions about when private agents learn of fiscal actions can produce a classical economy whose nominal equilibrium depends on the process for lumpsum taxes and whose time series contradict the view that monetized deficits predict inflation. I assess the fit of versions of the model to U.S. data and reinterpret existing reduced-form studies in light of the results.
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- Evans, Paul, 1987. "Interest Rates and Expected Future Budget Deficits in the United States," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 34-58, February.
- King, Robert G. & Plosser, Charles I., 1985. "Money, deficits, and inflation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 147-195, January.
- Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
- Dwyer, Gerald P, Jr, 1982. "Inflation and Government Deficits," Economic Inquiry, Western Economic Association International, vol. 20(3), pages 315-329, July.
- Rao Aiyagari, S. & Gertler, Mark, 1985. "The backing of government bonds and monetarism," Journal of Monetary Economics, Elsevier, vol. 16(1), pages 19-44, July.
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