Are Bond-Financed Deficits Inflationary? A Ricardian Analysis [report]

Bennett McCallum
1982 unpublished
This paper considers the possible theoretical validity of the following "monetarjst hypothesis": that a constant, positive government budget deficit can be maintained permanently and without inflation if it is financed by the issue of bonds rather than money. The question is studied in a discrete-time, perfect-foresight version of the competitive equilibrium model of Sidrauski (1967) , modified by the inclusion of government bonds as a third asset. It is shown that the monetarist hypothesis is
more » ... rist hypothesis is invalid if the deficit is defined exclusive of interest payments, but is valid under the conventional definition. It is also shown that the stock of bonds can grow indefinitely at a rate in excess of the rate of output growth, provided that the difference is less than the rate of time preference. In addition to the main analysis, the paper includes comments on alternative deficit concepts, a brief consideration of data pertaining to the announced budget plans of the Reagan administration, and a new look at a muchstudied issue: whether the operation of a Friedman-type constant money growth rule (with non-activist fiscal rules) would be dynamically feasible. * economy is Ricardian, d is preferred to d and the argument is just as above. If, on the other hand, the economy is not Ricardian, the inflationary impact of a given percentage change in M+B will depend upon the mix of money and bonds. Thus no single measure will be fully adequate. If one
doi:10.3386/w0905 fatcat:cd7t2qoo6rgazpjwh5t47fraim