Fiscal Policy, Anticipated Switches in Methods of Finance, and the Effects on the Economy.

This paper develops a full employment, constant population macroeconomic model with forward-looking consumers that have finite horizons. The model is designed to analyze the effects on the economy of a current bond-financed cut in taxes or an increase in government expenditures when the resulting deficits are anticipated to be closed by a mixture of tax finance and money finance in the future. The model implies that deficits and real interest rates may not be positively correlated, contrary to popular views, and that deficits and inflation may exhibit a variety of patterns depending on how the deficits are expected to be closed in the future. Copyright 1990 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.