As I noted in my article describing the impact of rising rates on fiscal policy, my model did not follow standard conventions in mainstream economic analysis. This was deliberate, as I feel that standard analysis techniques have limitations when analysing fiscal policy dynamics. I will break up this discussion into a several posts, each discussing one topic, as there is considerable background information to cover for each subject.
A great deal of analysis of fiscal policy is based upon analysing the trend in the primary budget balance. I explain in this post why this is a mistake, as the primary budget balance gives a misleading view of fiscal settings…Bond Economics
What Is The Primary Fiscal Balance, And Why Its Use Should Be Avoided
Brian Romanchuk
Take away:
The paper “Fiscal Policy In A Stock-Flow Consistent Model”, by Wynne Godley and Marc Lavoie, gives a more formal explanation of how to approach fiscal policy using SFC models. They have a number of results within that paper, but here is one interesting point with regards to "explosive" debt dynamics:
Our simple SFC model can, however, provide us with a more surprising result. It is usually asserted that for the debt dynamics to remain sustainable, the real rate of interest must be lower than the real rate of growth of the economy for a given primary budget surplus to GDP ratio. If this condition is not fulfilled, the government needs to pursue a discretionary policy that aims to achieve a sufficiently large primary surplus. We can easily demonstrate that there are no such requirements in a fully-consistent stock-flow model such as ours.
They additionally argue that the emphasis on monetary policy is misplaced, and that fiscal policy could theoretically achieve the inflation and output targeting that has been currently delegated to central banks.
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