Abstract
Even under constant returns to scale technology there is a positive profit return if the goods are produced in monopolistic competition. By a two-periods overlapping generations (OLG) model with production in monopolistic competition under constant returns to scale in which the economy grows by technological progress and the older generation consumers receive the profits, we consider the problem of budget deficit. We show that the budget deficit equals the difference between the net savings of the younger generation consumers excluding the profits received in the future and that of the older generation consumers in each of the following cases. Also, the following results will be proved. 1) A budget deficit is necessary to realize full employment with constant price when the economy grows. 2) If the budget deficit exceeds the level necessary and sufficient to maintain full employment in a growing economy with constant price, inflation will occur. A stable budget deficit is necessary to prevent further inflation. 3) If the budget deficit is insufficient to maintain full employment, a recession with involuntary unemployment occurs. We can overcome a recession and restore full employment making a budget deficit larger than the one necessary and sufficient to maintain full employment without a recession. Since we can maintain full employment by constant budget deficits, we should not offset the deficit created for overcoming the recession by budget surpluses.
Highlights
In previous studies we examined the arguments for fiscal policy by Lerner’s (1943, 1944) Functional Finance Theory and MMT (Modern Monetary Theory, Wray (2015), Mitchell, Wray and Watts (2019), Kelton (2020))1 by a static model or an overlapping generations model of perfect competition with constant returns to scale technology
By a two-periods overlapping generations (OLG) model with production in monopolistic competition under constant returns to scale in which the economy grows by technological progress and the older generation consumers receive the profits, we consider the problem of budget deficit
In order to include the existence of corporate profits in the analysis, it is possible to consider the case of production using labor and capital, but this paper deals with a simpler model of monopolistic competition with constant returns to scale in which labor is the only production factor
Summary
In previous studies we examined the arguments for fiscal policy by Lerner’s (1943, 1944) Functional Finance Theory and MMT (Modern Monetary Theory, Wray (2015), Mitchell, Wray and Watts (2019), Kelton (2020)) by a static model or an overlapping generations model of perfect competition with constant returns to scale technology. Using a two-periods (two-generations) overlapping generations model with production in monopolistic competition under constant returns to scale technology in which the economy grows by technological progress and the older generation consumers receive the corporate profits, the following results will be proved. 2) If the budget deficit exceeds the level necessary and sufficient to maintain full employment in a growing economy under constant price, inflation will occur. This may have the effect of lowering interest rates, but it will not directly increase demand for goods and will not cause high-rate inflation because people's assets will not increase (unless the central bank buys them at prices above face value) and it will not generate income If it is done during a recession, even low-rate inflation will not occur. In Appendix we will show that if the profit returns are received by the younger generation consumers, the budget deficit equals the difference between the savings of the younger generation consumers and that of the older generation consumers
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