Research Discussion Paper – RDP 8201 Money, Wealth, and Prices: An Empirical Analysis

Abstract

This paper examines the implications for macroeconomic activity of alternative methods of financing a government budget deficit.

A simple theoretical model is presented to illustrate the point that, if all assets are treated symmetrically, the method chosen to finance a government budget deficit is of little consequence to macroeconomic activity relative to the effects of the deficit itself. This simple model is then expanded into a portfolio model consisting of money, government bonds, bank advances and foreign liabilities. Two versions of this portfolio model are derived. One is based on the assumption that portfolios adjust slowly. The other version is based on the assumption that portfolios adjust instantaneously. These two portfolio models are incorporated into a recent version of the RBII model of the Australian economy. The two resulting models are estimated as part of the full system of equations which is then used to simulate a number of monetary and fiscal shocks.

The results suggest that budget deficits appear to be a main cause of inflation and the method used to finance these deficits may only be of secondary importance. It also appears that 'monetary disequilibrium' in the RBII model is a reasonable approximation to a more complicated adjustment process arising from changes in wealth.