Budget Deficit and ‘The World’s Smallest Macroeconomic Model’ by Paul Krugman

In his "The World’s smallest macroeconomic model” (Krugman(1999)), Paul Krugman argued that under the assumption of price rigidity, a shortage of money supply leads to underemployment or recession, so increasing money supply can eliminate underemployment and restore full employment. But, how do we increase the money supply? I will show that we need a budget deficit to increase the money supply in order to restore full employment from recession. Also, I will show that in a growing economy, if people hold money, a budget deficit is necessary to maintain full employment under constant price or inflation. A budget deficit is not only effective in pulling the economy out of recession, it is even necessary for continued growth without inviting either recession or inflation