On Government Deficits and Speculation.

The authors consider a dynamic stochastic general equilibrium model with a representative consumer-investor and two producing firms. All the assets are real investments of capital into productive processes. Government expenditures, taxes, and money financing are explicitly incorporated. The holding of money is modeled through a cash-in-advance constraint. "Fundamental budget deficits" generated by flat rate expenditure and income tax rules can be financed by printing money or randomly levying temporary wealth taxes modeled as a Poisson process. Characterization and properties of the "balanced-budget" rational expectations equilibrium are analyzed. It is shown that government may promote growth by adjusting the fundamental deficit. Copyright 1990 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.