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Asset Prices, Substitution Effects, and the Impact of Changes in Asset Stocks


  • Carl E. Walsh


The standard result in macroeconomic models is that an increase in the stock of government debt has an ambiguous effect on aggregate demand. Models which have derived this result have assumed that all assets are gross substitutes. Some recent work within the framework of mean-variance portfolio models, however, seems to imply that the assumption that all assets are gross substitutes is sufficient to determine whether an increase in government debt is expansionary or contractionary. This apparent inconsistency is resolved by showing that gross substitutability is sufficient to sign the impact of a change in government debt only when money is riskless. To carry out the analysis, portfolio choice and equilibrium asset prices are characterized in a new way through the use of a distance function.

Suggested Citation

  • Carl E. Walsh, 1980. "Asset Prices, Substitution Effects, and the Impact of Changes in Asset Stocks," NBER Working Papers 0566, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0566
    Note: ME

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    1. repec:fth:prinin:126 is not listed on IDEAS
    2. repec:pri:indrel:dsp013r074t93w is not listed on IDEAS
    3. Deaton, Angus, 1981. "Optimal Taxes and the Structure of Preferences," Econometrica, Econometric Society, vol. 49(5), pages 1245-1260, September.
    4. Blanchard, Olivier J & Plantes, Mary Kay, 1977. "A Note on Gross Substitutability of Financial Assets," Econometrica, Econometric Society, vol. 45(3), pages 769-771, April.
    5. Cohen, Darrel & McMenamin, J Stuart, 1978. "The Role of Fiscal Policy in a Financially Disaggregated Macroeconomic Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 322-336, August.
    6. Angus Deaton, 1979. "The Distance Function in Consumer Behaviour with Applications to Index Numbers and Optimal Taxation," Review of Economic Studies, Oxford University Press, vol. 46(3), pages 391-405.
    7. Roley, V Vance, 1979. "A Theory of Federal Debt Management," American Economic Review, American Economic Association, vol. 69(5), pages 915-926, December.
    8. Cass, David & Stiglitz, Joseph E., 1970. "The structure of investor preferences and asset returns, and separability in portfolio allocation: A contribution to the pure theory of mutual funds," Journal of Economic Theory, Elsevier, vol. 2(2), pages 122-160, June.
    9. Yung Chul Park, 1972. "Some Current Issues on the Transmission Process of Monetary Policy (Le processus de transmission de la politique monétaire: quelques questions d'actualité) (Algunas cuestiones de actualidad sobre el," IMF Staff Papers, Palgrave Macmillan, vol. 19(1), pages 1-45, March.
    10. Walsh, Carl E., 1982. "Asset substitutability and monetary policy : An alternative characterization," Journal of Monetary Economics, Elsevier, vol. 9(1), pages 59-71.
    11. James Tobin & William C. Brainard, 1962. "Financial Intermediaries and the Effectiveness of Monetary Controls," Cowles Foundation Discussion Papers 63R, Cowles Foundation for Research in Economics, Yale University.
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