Stabilization effect of endogenous money supply in a descriptive neoclassical growth model

Abstract

This paper develops a neoclassical monetary growth model with myopic perfect foresight in which monetary expansion rate changes with government budget deficit or surplus. We show the saddlepoint instability of the neoclassical monetary growth model assuming that the constant money growth policy can be avoided under the endogenous money supply rule. We also compare the purely money-financed regime where no government bonds exist with the mixed-financed strategy under which government deficit is partly financed by issuing interest-yielding securities. Our result suggests that the destabilizing effect of bond financing, which has been frequently observed in Keynesian macrodynamic models, does not necessarily hold in the neoclassical system.