Monetary and Fiscal Policies in an Inflationary Economy: A Simulation Approach

Abstract

ONE OF THE MAJOR DEVELOPMENTS in macroeconomic theory in recent years has been the analysis of dynamic systems in which a fundamental cause of the dynamics is the government budget constraint. The fact that the financing of a government deficit or surplus will give rise to an intrinsically dynamic system was first noted by Ott and Ott [6] and Christ [3, 4] who considered its implications for monetary and fiscal policy in relatively simple models. Subsequently this work has been extended in a variety of ways by several authors, see, e.g., [1, 10, 12]. 1 The usual strategy adopted in this literature is to consider an instantaneous (short-run) equilibrium and a steady-state (long-run) equilibrium and to use conventional comparative static techniques to analyze the short-run and long-run effects of various policy changes. Also, insofar as is possible, stability conditions are analyzed in order to determine whether or not a system disturbed from an initial equilibrium will in fact converge to a new steady state. Although these procedures are, and presumably will remain, fundamental