William Scarth

Bond financed fiscal policy and the problem of instrument instability

Abstract Previous analyses of bond financed government expenditure policies have indicated stability problems but have considered only a once-for-all and sustained increase in government spending. In this paper we examine the bond financing of temporary government expenditure changes, which form part of an ongoing policy designed to “balance the budget over the business cycle.” We find that an endogenous fiscal policy can keep national output near its target value but that the effects on the national debt and the size of the public sector are likely not to be transitory. There is a strong tendency toward instrument instability, in that control of the economy forces the level of government spending to forever diverge from its equilibrium value.

Rational expectations and the instability of bond-financing

Abstract Models involving the government budget constraint are generally unstable when deficits are bond-financed; while rational expectations models involve restrictions which preclude unstable solutions. This note integrates these approaches and shows that rational expectations is inconsistent with convergence when deficits are bond-financed.

Inflation and unemployment : the evolution of the Phillips curve

This authoritative three-volume collection provides a comprehensive anthology of many of the most important and influential articles written since the publication of Phillips’ 1958 study – the most-cited macroeconomic paper published in the 20th century. Along with an original introduction by the editors, the papers evaluate the original contribution and place it in its historical context. The works also discuss the strengths and weaknesses of the New Classical critique and the expectations augmented Phillips Curve that resulted from it, and critique the part played by the ‘New Keynesian Phillips Curve’ in the New neo-Classical Synthesis that has emerged in macroeconomics. This indispensable volume will be of immense value to students, scholars and practitioners interested in the field of economics, and the Phillips Curve in particular.

Can fiscal spending be contractionary when interest rates have supply-side effects?☆

Abstract Can increased government spending cause a temporary recession? The answer is yes, if there exist direct aggregate supply-side effects of interest rates. Existing studies of this issue are incomplete for two reasons. First, the aggregate-demand and aggregate-supply effects of interest rates are not specified within an internally consistent framework and so cannot be compared properly. Second, interest rate expectations effects are ignored. This paper eliminates both these shortcomings and therefore better establishes the empirical relevance of the supply-side effects of interest rates. Nominal interest rates above 6% are sufficient for fiscal policy perversity.

Aggregate Demand- Supply Analysis and Its Critics: An Evaluation of the Controversy

While acknowledging that the AD-AS model is sometimes applied carelessly, this note defends this analytical framework against charges that it is internally inconsistent, empirically unrealistic, and unable to clarify major controversies in macroeconomic theory and policy. JEL classification: A22, B22, E10

A note on non-uniqueness in rational expectations models

Abstract McCallum has proposed a solution procedure for rational expectations models - undetermined coefficients with the minimal set of state variables - which can avoid the non-uniqueness problem. This procedure often requires some additional restrictions on the admissible values of the structural parameters. In this note we show that in some cases, these parameter restrictions may be defended with less ambiguity by considering the dynamics of the model, rather than examining particular parameter values, as suggested by McCallum.

The Effects of Economic Stability of Indexing the Tax System and Government Bond Yields for Inflation

The effects on economic stability of indexing the tax system and government bond yields for inflation. A standard, fairly classical, macro model is used to examine the stability implications of indexation. The analysis includes fornmal stability conditions and, among other things, shows that there are definite stability problems stemming from the larger nominal transfer payments to households that are implied by indexing government bond yields. A government budget constraint is used in the model to recognize explicitly this financing burden which automatically increases with inflation. Financing through money creation feeds the inflation, and financing through bond sales increases the deficit for the next period. Both financing options represent explosive processes.

A note on the ‘crowding out’ of private expenditures by bond-financed increases in government spending

Abstract In a recent paper in this Journal, Blinder and Solow (1973) examine a dynamic IS-LM model. They prove that bond-financed fiscal policy is ineffective (which is the view of monetarists) only if the basic model is unstable. They claim that empirical evidence for the U.S. suggests that the model is stable, however, so that the evidence supports the proposition that fiscal policy matters. The purpose of this note is to point out an error in the stability condition reported by Blinder and Solow, and to demonstrate that their conclusions about the United States economy are without foundation.

User Discretion Advised: Fiscal Consolidation and the Recovery

Since the financial crisis in 2008, controversy has existed over whether governments should use fiscal policy in an attempt to stimulate economic activity, or whether fiscal consolidation is preferred. Those who call for continued stimulation focus on how slow and incompletely shared our recovery has been, while those favouring austerity argue that postponement of deficit and debt reduction retards business expansion, thereby hurting the recovery. This study evaluates the many strands of this fiscal policy debate, and applies the lessons to the decisions currently facing the federal and Ontario governments.The main conclusions are:• In normal times, fiscal policy should focus on allocation and distribution questions – public good provision, support for those on low incomes, and debt control – and should not focus on the short-run cycles in economic activity. Cyclical problems are normally best addressed by relying on monetary policy to strengthen the economy’s self-correction mechanism.• In non-normal times – involving very low interest rates and synchronized recessions across countries – monetary policy is relatively ineffective and fiscal policy is decidedly more effective than usual. This situation – precisely what we have been confronting since 2008 – is the exception to the general rule. In this case, fiscal policy should take an active part in stabilization initiatives.• The federal government should delay its final stage of deficit reduction by three years. If its deficit-to-GDP ratio is held at one-half of one percentage point for three years before reducing it to zero, it is estimated that the nation’s unemployment rate would be four-tenths of one percentage point lower during this three-year period. This opportunity to help working Canadians should not be passed up – especially when the cost in terms of reaching the government’s stated debt-ratio target of 25 percent by 2021 is so small – a missing of that target by just one percentage point. • The federal government’s deficit and debt targets are internally inconsistent. A debt-ratio target of 25 percent – along with an ongoing nominal GDP growth rate of 4 percent – requires a permanent deficit ratio of 1 percent, not zero. The government could achieve internal consistency by eventually lowering its debt target to zero. However, achieving consistency by raising its deficit target back up to 1 percent makes more sense when there are other short-term-pain-for-long-term-gain initiatives that are needed to address more pressing objectives than lowering a debt ratio that is already the envy of the world. • The Ontario government should address its long-term sustainability challenge before it embarks on major new expenditures. Policy-created uncertainty cannot be overcome when the government’s plans involve an increase in the deficit before it may start to decline. Infrastructure investments are particularly appealing when borrowing costs are low, but credibility requires that these debt service costs be covered by well-identified reductions in the operating expenses associated with existing government programs.

Is policy perversity consistent with Keynesian business cycles

Abstract It has long been recognized that higher spending can, by raising interest rates and thereby firms’ short-run marginal costs, have stagflationary supply-side effects. This possibility has attracted little attention, probably because it seems inconsistent with the Keynesian view that recessions are caused by decreases, not increases, in demand. This note clarifies these issues by distinguishing between one-time and ongoing changes in spending, and concludes that the relevance of the fiscal perversity hypothesis is increased by the ongoing changes in how monetary policy is conducted.