DP192 | Government Deficits and Speculation

Publication Date

01/09/1987

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Abstract

We consider a simple general equilibrium model for the determination of asset prices together with full equilibria in the commodity and money markets. In this way portfolio aspects are introduced into a dynamic macro model which has many features from growth theory. Money holdings are modelled through a simple cash-in-advance constraint and all the assets are real investments of capital into productive processes. The government budget constraint is also explicitly incorporated. In this framework we generalize the distinction between anticipated and unanticipated policies into probabilistic anticipations about some money-financed fiscal policies. As the analytically simplest case we study the effects of temporary taxes that are randomly introduced. These surprise taxes are foreseen by consumers and influence their portfolio investment allocations. Moreover, consumers' expectations regarding the introduction of surprise taxes alter the variability of the government "fundamental deficit", so that the naive idea of using surprise temporary taxes to control the cumulative deficit does not work in general. It is, however, possible to devise a sophisticated scheme that in a rational expectations framework achieves intertemporal government budgetary balance.