Table Of ContentDEBT, DEFICIT AND ECONOMIC PERFORMANCE
CENTRAL ISSUES IN CONTEMPORARY ECONOMIC THEORY AND POLICY
General Editor: Mario Baldassarri, Professor of Economics, University of Rome
'La Sapienza', Italy
This new series is a joint initiative between Macmillan, St. Martin's Press and SIPI, the
publishing company ofConfindustria (the Confederation of Italian Industry), based on
the book collectionMONOGRAFIE RPE published by SIPI and originated from the new
editorial programme of one of the oldest Italian journals of economics, the Rivista di
Politica Economica, founded in 1911. This series is intended to become an arena in which
the most topical economic problems are freely debated and confronted with different
scientific orientations and/o r political theories.
The 1990s clearly represent a transition period in which the world economy will
establish new international relationships and in this context, new challenges and new
risks will have to be faced within each economic system. Fundamental issues on which
economic theory and policy have long based their reasoning over the last two or three
decades have to be critically reviewed in order to pursue new frontiers for theoretical
development and economic policy implementation. In this sense, this new series aims
at being a "place of debate" between professional economists, an updated learning tool
for students and a specific reference for a wider readership aiming at understanding
economic theory and policy evolution even from a non-specialist point of view.
Published
Mario Baldassarri (editor)
KEYNES AND THE ECONOMIC POLICIES OF THE 1980s
Mario Baldassarri (editor)
INDUSTRIAL POLICY IN ITALY, 1945-90
Mario Baldassarri (editor)
OLIGOPOLY AND DYNAMIC COMPETITION
Mario Baldassarri, John McCallum and Robert Mundell (editors)
DEBT, DEFICIT AND ECONOMIC PERFORMANCE
Mario Baldassarri, John McCallum and Robert Mundell (editors)
GLOBAL DISEQUILIBRIUM IN THE WORLD ECONOMY
Mario Baldassarri and Robert Mundell (editors)
BUILDING THE NEW EUROPE
VOLUME 1: THE SINGLE MARKET AND MONETARY UNIFICATION
VOLUME 2: EASTERN EUROPE'S TRANSITION TO A MARKET ECONOMY
Mario Baldassarri, Luigi Paganetto and Edmund S. Phelps (editors)
INTERNATIONAL ECONOMIC INTERDEPENDENCE,
PATTERNS OF TRADE BALANCES AND ECONOMIC POLICY
COORDINATION
Mario Baldassarri, Luigi Paganetto and Edmund S. Phelps (editors)
WORLD SAVING, PROSPERITY AND GROWTH
Debt, Deficit and
Econom.ic Perfortnance
Edited by
Mario Baldassarri
Professor of Economics
University of Rome 'La Sapienza'
Robert Mundell
Professor of Economics
Columbia University, New York
and
John McCallum
Professor of Economics
McGill University, Montreal
M
in association with
St. Martin's Press Palgrave Macmillan
© SIPI Sri. Rivista di Politica Economica 1990. 1993
Softcover reprint of the hardcover 1st edition 1993 978-0-333-58701-0
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First published in Great Britain 1993 by
THE MACMILLAN PRESS LTD
Houndmills, Basingstoke, Hampshire RG21 2XS
and London
Companies and representatives
throughout the world
A catalogue record for this book is available
from the British Library.
ISBN 978-1-349-22921-5 ISBN 978-1-349-22919-2 (eBook)
DOI 10.1007/978-1-349-22919-2
First published in the United States of America 1993 by
Scholarly and Reference Division,
ST. MARTIN'S PRESS, INC.,
175 Fifth Avenue,
New York, N.Y. 10010
ISBN 978-0-312-09057-9
Library of Congress Cataloging-in-Publication Data
Debt, deficit and economic performance I edited by Mario Baldassarri,
Robert Mundell, and John McCallum.
p. em.
"[Published by St. Martin's Press] in association with Rivista di
Politica Economica, SIP!, Rome."
Includes index.
ISBN 978-0-312-09057-9
1. Debts, Public. 2. Budget deficits. 3. Fiscal policy.
4. International economic relations. I. Baldassarri, Mario, 1946-
11. Mundell, Robert A. III. McCallum, John, 1950-
HJ8015.D425 1993
336-dc20 92-26618
CJP
Contents
PART 1: THEORETICAL DEVELOPMENTS
1 Debt and Deficits in Alternative Macroeconomic Models 5
Robert A. Mundell
2 The Debt Money Ratio: What are the Limits? 131
Alvaro Rodriguez
3 Government Spending and National Saving 151
John McCallum
4 Finite Horizons, Infinite Horizons, and Stock Prices 169
Paul Evans
PART II: INTERNATIONAL EMPIRICAL EVIDENCE
5 The Effects of Industrial Country Fiscal Policies on 195
Developing Countries in the 1980s
Paul R. Masson, John F. Helliwell
6 The Effect of the Tax System on the Impact of Government Debt 233
William Vickrey
7 Alternative Tax Systems and Structural Change 241
Margherita Carlucci, Martino LoCascio, Luigi Paganetto
8 Staggered Wage Setting and the International Transmission 267
of Policy Announcement Effects
Steve Ambler
9 Consumption, Uncertainty and Ricardian Equivalence 291
Jagdish Handa
10 The Burden of Government Debt in an Almost 319
Small Open Economy
David F. Burgess
PART III: THE EXPERIENCES OF SOME COUNTRIES
11 The Government Budget and the Italian Economy During 341
the 1970s and 1980s: Causes of the Debt, Strategy for Recovery,
and Prospects for Restructuring
Mario Baldassarri, M. Gabriella Briotti
12 Public Sector Debt and Deficit in Greece: The Experience 405
of the 1980s and Future Prospects
Yannis A. Stournaras
13 Debts and Deficits in Australia 441
Larry Sjaastad
Index 482
I- THEORETICAL DEVELOPMENTS
Debts and Deficits
in Alternative Macroeconomic Models
Robert A. Mundell
Columbia University
1. - Introduction
Ever since Keynes challenged the classical automaticity approach
to macroeconomics, the economics profession has been engaged in a
prolonged debate over the appropriate roles of monetary, fiscal, debt
and exchange rate policies in economic management. In the two
decades following the publication of the General Theory, Keynesian
views were predominant in macroeconomic theory and economic
policy. Classical views, however, were sustained by the abortive
Keynesian prediction of a post-war depression. Control of inflation
became a major objective of macroeconomic policy.
Initially, classical theory had been on the defensive, attempting to
rebut Keynes' criticism of the classical doctrine of automaticity (1).
But comparative success in control of the business cycle in the first
two decades of the post-war era (2) heightened interest in the
mainstream of classical thinking. A revised classicism emerged that
(1) The classical counterattack initially centered on the refutation of Keynes'
fundamental assertion that an unemployment equilibrium could exist at less than full
employment even if wages and prices were flexible. The main feature of the revised
classical position was the real balance effect, as part of a more general wealth effect, but
the new doctrine utilized the framework of the Keynesian expenditure function. With
flexible wages and prices, deflation would raise real money balances and thus expen
diture until full employment was restored. The Keynesian rebuttal was that the wealth
effect would apply only to outside money and would in any case be too insignificant to
rely on for policy purposes.
(2) To Keynesians, this is a badge of distinction due to their belief that Keynesian
policies can prevent a great depression.
6 Robert A. Mundell
owed much to Ricardo, Walras and Irving Fisher. Instead of the
Keynesian variables of income, saving, investment, employment and
money, it emphasized wealth, equilibrium analysis, the inter-temporal
budget constraint, rational expectations, technological change and
supply-side incentive effects.
Of the four main dimensions of fiscal policy: stabilization policy,
allocation policy, distribution policy and the provision of public goods,
Keynes had emphasized stabilization objectives, a function mentioned
only in passing by the laissez-faire economists of the old classical
school. The reconstructed classical school emphasizes optimal pro
vision of public goods and, more recently, the supply-side incentive
effects of alternative tax systems. It has not, however, succeeded in
displacing disequilibrium theory and stabilization objectives from
actual monetary and fiscal policy and it can be argued that Keynesian
and new classical premises are complements rather than substitutes.
Keynesian macroeconomics uses a short run model of an economy
containing rigidities, whereas the classical macroeconomics is a model
in which the rigidities have had time to become variables!
Historically, changes in monetary, fiscal, debt and currency
policies have been influenced by shifts in the nature of the Interna
tional Monetary System. Monetary and fiscal programs have to be
compatible with the exchange rate systems linking each economy to
the rest of the world. The gold standard of the nineteenth century
punished all deviation from monetary and fiscal discipline with finan
cial crises, and thus set the tone for fiscal conservatism. To an
important extent this was also true of the gold exchange standards
that were set up after the two world wars. Despite important differen
ces, the international gold standard of the pre-1914 era, the interna
tional gold exchange standard set up in the 1920s and the gold-dollar
exchange standard that prevailed from 19 34 to 1971 were all fixed
exchange rate systems anchored by gold.
The monetary and fiscal discipline is different under fluctuating
exchange rates. An extra degree of freedom is available to the
monetary authorities which they can use to create a different rate of
inflation from that of other countries. Thus if the inflation rate in
other countries is too high, the domestic country can follow a more
conservative monetary policy and allow its currency to appreciate,
