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Monetary-Fiscal Policy and the Debt Burden**

Published online by Cambridge University Press:  19 October 2009

A. Benavie
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Extract

The “burden of the debt” still appears to be a matter of concern to the United States public, economic teaching notwithstanding. In the debates preceding the 1964 tax cut, such matters as the existing budgetary deficit and the swelling public debt evoked as much passion as confusion. In this paper we intend to focus on one question: will a tax cut designed to generate a full employment equilibrium necessarily increase the debt burden, as defined by Domar. In particular, we are interested in the impact of a tax reduction on the debt burden, given that a budgetary deficit exists; and under the condition that the monetary authorities have decided to tighten credit conditions. We shall assume throughout that interest rates are determined by the monetary authorities, and that their policy is dictated by balance of payments rather than aggregate demand considerations. it will also be assumed that the tax reduction takes into account any planned increase in the rate of interest. Finally, we assume that budgetary deficits are financed by borrowing from the nonbank public and not by new money.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 1 , Issue 3 , September 1966 , pp. 108 - 124
Copyright
Copyright © School of Business Administration, University of Washington 1966

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References

1 The debt burden is defined as the ratio of interest payments on the publicly held debt to national income. See “The Burden of the Debt and the National Income,” American Economic Review, December, 1944.

2 We shall not be concerned here with the issue of whether the debt burden is or is not a burden, or whether Domar's definition is or is not suitable. It does seem, however, that if a tax cut raised income by more in absolute terms than it raised interest payments that welfare would be increased and a tax cut will certainly do that.

3 Our analysis can easily incorporate other, assumptions, i.e., that interest rates fall, or that the monetary authority has other objectives. Also, our model could make the interest rate endogenous and spell out the monetary sector in the usual manner. This merely adds complexity without serving the purpose of this paper.

4 For a similar technique applied to a surplus, see Musgrave, R. A., The Theory of Public Finance, (New York: McGraw-Hill Book Co., Inc., 1959),. PP 439–440Google Scholar. Musgrave's treatment does not include the interest rate, the interest payments on the deficit or the marginal propensity to invest. He shows that a decrease in t will lower the surplus if the MPC < 1. An additional term could be added to dR; the change in the interest rate multiplied by refinanced debt. We exclude this for the simplicity of our illustration.

5 More rigorously, since

Since we assume our comparative static system is stable, thus a negative function of Yo.

6 All dollar figures are of course in billions.