The budget deficit and inflation under full employment

Abstract

A monetarist model of the economy is constructed and it is shown, within
the context of that model, that a reduction in the money supply can lead to a
rise in inflation in the future as Sargent and Wallace (1984) predicted, only if
fiscal policy is defined as exclusive of interest rate payment on debt. The
conclusions of the paper are directly relevant to current Greek macroeconomic
problems and the solutions proposed for them, in that they point out the
importance of formulating goverment policy on receipts and expenditures after
thorough consideration of interest payments on past debt and after giving careful
attention to the money-bond mix of financing the deficit.