Working Paper

Policy rules, information and fiscal effects in a \"Ricardian\" model

Abstract: 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.

Keywords: Monetary policy; Fiscal policy; Deficit financing;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 1989

Number: 360