The government budget constraint with endogenous money☆

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Abstract

This paper examines the effectiveness and stability of fiscal policy in a model with a budget constraint and an endogenous money stock. This model avoids the need to treat only two polar cases, pure bond and pure money financing-neither of which is appropriate given the structure of the monetary system and the way monetary policy has been conducted historically. Furthermore, the model allows one to differentiate the effects of a money-financed deficit for the different tools of monetary control. We find that neither the long-run effectiveness nor stability of a mixed bond/money financed deficit is invariant to the monetary policy tool used.

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☆

I would like to thank Hiroaki Hayakawa and an anonymous referee for helpful comments on an earlier draft of this paper. The views expressed here are those of the author and not necessarily those of the Federal Reserve Bank of St. Louis or the Federal Reserve System.

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