The dynamic effects of fiscal and monetary policies under bond financing: A theoretical simulation approach to crowding out

This paper uses simulation methods to analyze the effectiveness of fiscal and monetary policy within a reasonably rich dynamic macroeconomic model, characterized by secular inflation. The most clear cut result to emerge is that fiscal expansion, specified as being an increase in government expenditure, leads to instability. This finding confirms the conclusions obtained from more formal analyses of simpler systems. In most of the sample sets considered, the instability takes the form of crowding out, whereby the initial expansion creates subsequent recessionary pressures. However, in a minority of cases, the nature of the instability is reversed and takes the form of an explosive boom.