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of Economic Research
Volume Title: International Aspects of Fiscal Policies
Volume Author/Editor: Jacob A. Frenkel, ed.
Volume Publisher: University of Chicago Press
Volume ISBN: 0-226-26251-
Volume URL: http://www.nber.org/books/fren88-
Publication Date: 1988
Chapter Title: Expansionary Fiscal Policy and International Interdependence
Chapter Author: Linda Kole
Chapter URL: http://www.nber.org/chapters/c
Chapter pages in book: (p. 229 - 272)
7 Expansionary Fiscal
Policy and International
Interdependence
Linda S. Kole
7.1 Introduction In the 1980s, the large magnitude of current and expected U.S. budget deficits has led to renewed interest in the effects of fiscal expansion in an open, macroeconomic environment. We have witnessed a fascinating episode of real dollar appreciation, high real interest rates, and growing U.S. current account deficits. Many elements of this experience are well-explained by economic theory. For instance, the classic Mundell- Fleming analysis of fiscal expansion in a large country leads one to the conclusion that the exchange rate will appreciate while the trade bal- ance deteriorates and world real interest rates rise. Given the size of the U.S. fiscal expansion, it is not particularly surprising that we have observed these effects. What is difficult to explain is the precise mag- nitude of the changes and the pattern of events that occurred. The steady rise in the dollar and the serious deterioration of the trade balance from 1980 to 1985 prompted many observers to assert that the dollar had become overvalued. If the dollar was indeed overvalued, it is important to gauge how much of its overvaluation stemmed from the expansionary fiscal stance in the United States. Another related question is: How much of the rise in real interest rates, at home and abroad, resulted from the increase in government borrowing? The fact
Linda S. Kole is an economist in the Division of International Finance, Board of Governors of the Federal Reserve System. This chapter was prepared while the author was an assistant professor of economics at the University of Maryland. Financial support from the University of Maryland General Research Board is grate- fully acknowledged. Also, the author thanks Margarida Mateus for excellent research assistance. This work represents the views of the author, and should not be interpreted as representing the views of the Board of Governors of the Federal Reserve System.
229
231 Expansionary Fiscal Policy and International Interdependence
and net foreign asset decumulation, is contrasted with the two-country case, in which the subsequent dynamics are not as clear-cut. It is shown that if assets are imperfect substitutes, or if there exists a large degree of initial capital market integration, then an increase in government spending can lead to quite a different path of dynamic adjustment. After the initial appreciation at the moment of the fiscal expansion, the exchange rate may continue to appreciate while current account sur- pluses cause accumulation of net foreign assets. This type of adjustment path is consistent with the current account being primarily determined by the service account instead of by the conventional predominance of the trade balance. The next section of this chapter develops a two-counry model tailored to accentuate some of the channels through which a fiscal expansion in a large, open nation can affect the rest of the developed world (here proxied by the second country). The major focus of the analysis is the effects of fiscal policy on the real exchange rate, real interest rates, and the balance of payments. The results of both an unanticipated and an anticipated balanced budget expansion are discussed in section 7.3. In section 7.4, a bond-financed fiscal expansion is analyzed by pre- senting simulation results. Finally, in sections 7.5 and 7.6 we comment on the recent experience of the United States and draw some tentative conclusions.
7.2 T h e Model
The model developed below is quite similar to that of Sachs and Wyplosz (1984). However, their model was specific to the small country case, so it did not provide a mechanism for analyzing the international effects we are interested in. We consider two countries which produce distinct composite goods. Output is assumed to be fixed in each country in order to abstract from cyclical phenomena, and for increased tract- ability. This assumption allows us to highlight the interdependent nature of world interest rates and the exchange rate, leaving other repercussion effects aside. The model is a fairly standard macro model of goods markets; it is simplified considerably by omitting the money market. For analytical convenience, we impose symmetry on many parameters of the model across countries. Table 7.1 presents the model in its simplest form. Equation (1) is the national income identity which states that domestic real income, y, equals private absorption, Q, plus government spending on goods and services, g, plus the trade balance, T. The trade balance has been defined as the domestic country’s exports less its imports, in domestic real terms, and thus T appears negatively in the foreign equation and
is deflated by the real exchange rate, X = eP*/P.
232 Linda S. Kole
Table 7.1 The Model y = u + g + T = B y' = a' + g' - T / X = ji' n = (1 - u)yd + 6w - +r yd = rbd + r'Xb; + 7 - z
u* = ( I - u)y; + 6w' - _+r y;_* = rbf/X + r'bj + ji' - z* w = I% + bd + Xb; W ** = _fi_ + b; + bf/X T = --Ea + XE'U' + qX b = bd + bf = b$(r - (&/D - r')w + X b f ( r - (&/O- r)w**
X = i - P' + n[&; + 8'6; - ( I - 8)bd - ( I - 8 * ) 6 , + ( 8 b & + 8 * b ; , ) X ]
where 8 = bdo/wo = b$O) 8 ' = b,dwG = b$O)
0 5 n = [bj'w, + bf'wG1-I < m
b = bd + bf = rb + g - z
i = + boi (b = 0 ) = bGf* (9 = 0 )
b' = b; + bf = r'b' + g' - Z'
b = p ( b - b ) 6 , = (6 - bo)(l - e-pl) g, = p(6 - bo) (dd) - 6, = T + Xr'b; - rbf nfu = b: - b, = T + rGb;oX + r i b ; + b&i' - robf - b,$ - b ; o X
it = boP, + (p + r&,
..
Note: All starred variables are in foreign currency terms. Variables with a tilde, f, represent deviations from the initial steady state, so that f = x - xg. Variables with a bar. f, represent constants while a variable 1, represents the time derivative, dx/dr. The first derivative of a function f ( x ) with respect to x is denoted as f'.
Private absorption in each country is defined in equation (2), where y d is real disposable income, w is real wealth, and r is the real interest rate. The inclusion of disposable income in the absorption equations introduces the implicit assumption that some agents in the economy are liquidity-constrained, so that a unit increase in current disposable income will be met by an increase in consumption of ( 1 -IT). Equation (3) defines disposable real income as real income plus interest earnings less taxes, where bd (b,) represent real domestic (foreign) holdings of domestic bonds, and b; (b;) are real domestic (foreign) holdings of
foreign bonds. For simplicity, taxes, z , are represented as a lump sum.
Absorption is specified as a negative function of the real interest rate. The implicit assumption is that savings respond positively to an increase in the real interest rate. Physical capital investment was excluded from the model to decrease the dimensionality of the dynamic system. How- ever, a part of absorption in this model could be thought of as invest- ment, in the form of inventory or durable goods investment. Private
234 Linda S. Kole
foreign bonds, ( r - (X/X)<>- Y),* where (AM). is the expected rate of real depreciation, hereafter assumed to be identical to the actual rate of depreciation. Linearizing equation (6) around the initial steady state and doing a bit of rearranging brings us to equation (7), the portfolio balance con- dition which governs the dynamic behavior of the real exchange rate
given perfect foresight. In this equation, X, has been set equal to one
for convenience. The parameters 8 and 8* represent the initial share of domestic bonds in domestic and foreign wealth respectively. R is the inverse of a wealth-weighted measure of the degree of asset substitut- ability. Note that as assets approach perfect substitutability R ap- proaches zero, and equation (7) becomes a statement of real interest
parity. However, as assets become less substitutable and R > 0, their
relative supplies start to matter.6 For instance, an increase in the stock of domestic bonds at home must, ceteris paribus, cause an appreciation
(X < 0) to decrease the real domestic return on foreign bonds and
eliminate excess supply in the domestic bond market. Next, we consider the public sector in each country by examining the governments’ budget constraints given by equation (8). Govern- ment spending and interest payments on outstanding bonds is financed by taxes or by issuing new bonds. In equation (9), we assume that the foreign country pursues a passive fiscal policy and does not change government spending (g* = 0). Foreign taxes are always adjusted to cover the government’s interest burden on outstanding bonds, so that the stock of foreign bonds remains constant. In contrast, we assume that the domestic government engineers a fiscal expansion. The evo- lution of taxes in the case of a balanced budget expansion is given by equation (9). On the other hand, suppose that the government undertakes a fiscal expansion without initially raising taxes. Then the ensuing deficit will be financed by bond creation. However, the government cannot in- crease the bond supply forever or the model would be ~ n s t a b l e. ~To rule out this possibility, we need a terminal condition to guarantee that eventually the government’s budget will be balanced. We adopt the condition proposed by Sachs and Wyplosz, equation (10a). This bond supply rule is convenient because it means that the domestic stock of bonds evolves independently of the other dynamic variables in the system. Equation (10a) implies that there is some target stock of out-
standing bonds, &, which the government shoots for. If this target
exceeds the existing stock of bonds, the government will continue to increase the supply of bonds up to E However, if b< b , the government will retire the debt at the rate k. Under this rule, a permanent fiscal expansion will lead to the evolution of bonds, government spending, and taxes described by equation (lob).
235 Expansionary Fiscal Policy and International Interdependence
When government spending increases, it is initially financed solely by bond creation. By assumption, taxes also increase automatically to cover the increase in debt service stemming from the fiscally induced increase in the real interest rate.8 Over time, less of the increase in g is financed by bond creation and more is financed by raising taxes. By the time the stock of outstanding bonds reaches its target level, taxes will have risen enough to cover both the increased government spending and the larger service on outstanding debt. Note that given rule (10) and the government budget constraint (8), the government’s choice of g and 6 will determine I.L. For a given fiscal expansion, the higher 6, the lower p, the rate of adjustment to the new steady state level of domestic bonds. Finally, the third dynamic relationship, the balance of payments in real domestic currency terms, is presented in equation (11). The left hand side of equation (11) is the change in net foreign assets held domestically. Under a perfectly flexible exchange rate regime, this cap- ital account deficit must match the current account surplus, which is the trade balance plus the service account on the right hand side of equation (1 1). The linearized version of equation (1 1) is given by equa- tion ( 1 l’). Note that the last term on the right hand side of equation ( 1 1 ’) represents capital gains on initial domestic holdings of foreign bonds. A real depreciation causes domestic residents to reap a capital gain of X ~ I : ~. If we assume that these gains are capitalized at each instant of time, then real depreciation will lead to a decumulation of net foreign assets as domestic investors cash in foreign bonds to realize their capital gains. It is difficult to know how one should treat capital gains because in actuality, they are not continuously capitalized and,
in the short run may be more important to central banks’ accounting
balances than to the balance of payments. In small country models capital gains are usually left out by defining the balance of payments and its components in foreign currency terms. However, in a two- country model, capital gains are difficult to ignore, except in the special case where initial holdings of foreign assets are nonexistent. A capital gain for one country represents a capital loss for the other; a capital gain in domestic currency terms is a capital loss in foreign currency terms. In the analysis that follows, we ignore the capital gains term because of the uncertainty involved with its treatment, but we do comment on how its inclusion would affect the results. Short-run goods market equilibrium of the system is described by solving equations (1) through ( 5 ) for r and _r_* as a function of X, g, and all asset stocks. Explicit algebraic treatment is given in the Appendix. We have assumed that initially the current account is in balance and that r, = r i , b:o = 6f0, To = 0, and X, = 1 to further simplify the analysis. Equilibrium is then described by:
237 Expansionary Fiscal Policy and International Interdependence
Below we present the system in abbreviated matrix form. The values of all of the coefficients in terms of the parameters of the system can be found in the Appendix; here we will only concern ourselves with
Because we have one jump variable, X, and one predetermined vari- able, nfu, we need the determinant of A to be negative for stability. If assets are perfect substitutes, the condition for a negative determinant
reduces to: ur;l < & l o This is likely to hold because u < 1 and in
equilibrium, _r_* = d.” In the case of imperfect substitutability with b;, = 0, we have a condition which is even more likely to be satisfied: ur; < S + i l ( 6 - 6)+/2.* As long as the domestic investors hold more domestic bonds than foreigners do as a share in wealth, the second term on the right hand side of the inequality is positive. The general condition for a negative determinant can be found in the Appendix. As is noted in system (13), the signs of the coefficients in the equation describing net foreign asset accumulation are ambiguous. To better understand the dynamics of the system, it is useful to examine how the signs of and a23 depend on the values or the model’s parameters. One crucial parameter in the dynamic system is the amount of foreign bonds held domestically (and vice versa-they are assumed to be equal here). In figure 7.1, we present a hypothetical example of how the mag- nitude of initial cross-country asset holdings affects the phase diagram of the system. The other parameter values used for this example are the same ones that will later be used for the simulations.I2 For sim- plicity, we analyze the perfect substitutes case so that equation (7a) collapses to 8 = P - ?*. Figure 7.la presents the dynamic phase diagram for the small country case that obtains when initial domestic holdings of foreign bonds are small or nonexistent. The X = 0 schedule describes asset market equilibrium when there is no expected appre- ciation or depreciation. The schedule slopes down because a depre- ciation raises the rate of return differential and must be accompanied
by a decrease in net foreign assets to decrease r - r* and maintain X
= 0. Above the schedule, r > r*, so there is portfolio imbalance unless
depreciation prevails. Below the schedule, appreciation is necessary for asset market equilibrium. The nfu = 0 schedule is the locus of points for which the current account is balanced. This schedule slopes
238 Linda S. Kole
Case (a 1 : b,: 0. 4 X Sign ( A ) =
Sign ( y ) = [ :] X = O
X Case (b) : 0.4 ,: b < 1.
Sign ( A ) =
L J^ x^ =O
nfa Case (c 1 : b,: > 1. X
Sign ( A ) = [I '
7 X=o
n i a = O
- = .8, u = .2, SZ = 0 , 6 = ro = r; = .05, E = E* = .3, q = .12.
Fig. 7.1 Examples of possible phase diagrams
down because a depreciation which improves the trade balance requires a decrease in net foreign assets and thus the service account to eliminate the current account surplus. To the right of the schedule, we have accumulation of net foreign assets through the service account, and to
the left, we have decumulation. Here the stability condition of a neg-
ative determinant implies that the X = 0 schedule must be steeper than the nfu = 0 schedule with the stable trajectory JJ between them. In the second panel of figure 7.1, we illustrate the dynamics of the system for a slightly higher range of initial foreign bond holdings. For this intermediate range of b20, the nfu = 0 schedule is positively sloped. A depreciation still has a positive effect on the current account, but now the net effect of an increase in net foreign assets on the current account is negative. As bk rises, the interest component of the current account becomes more important; the increase in the service account caused by ronfh is more than compensated for by the decrease due to
- bk(f - T J ). Over the range applicable to case (b), when bi0 is higher, the slope of the nfu = 0 schedule is steeper.
240 Linda S. Kole
Fig. 7.
I ^
(X=O,'
A Infa' nfao=O n f a
X
XC XI x X '
B
\ X=O \ \ ( X = O )
\
I l l nfa' nfo, nfao=O nfa
Balanced budget expansion (BBE) when assets are perfect substitutes (a = 0) and 62, = bf0 = 0. A , an unanticipated BBE. B, an anticipated BBE
the former because the increase in government spending causes an increase in the real rate of return differential, requiring an appreciation and/or a decrease in net foreign assets to restore steady state portfolio equilibrium. The current account schedule shifts inward because an increase in g directly improves the trade balance by shifting domestic demand from foreign to domestic goods, so either an appreciation or a decumulation of net foreign assets is necessary to restore current
account balance. The instantaneous effect is an appreciation to clear
the home goods market by choking off foreign demand. The exchange rate jumps from A. to A , , a point which is located on the trajectory to
241 Expansionary Fiscal Policy and International Interdependence
the new steady state equilibrium, A’. From that point on, the domestic country runs a current account deficit and undergoes depreciation until arriving at A’. In the long run, the expanding country experiences a loss in net foreign assets and probably an appreciation. The long-run changes in the level of net foreign assets and the real exchange rate are:
( 14a) nfu - nfuo = -[u/2(6 - ur(;)]g, and
( 14b) X - X, = [(at-: - 26~)/2q(6- u r : ) ] ~.
Given that 6 = r:, the condition for long-run real depreciation is u >
2 ~ .If this condition holds, the net effect of the increase in government spending on the current account is negative and a long-run real depre- ciation is necessary. This condition is unlikely to hold unless a country has quite a high propensity to save and a low marginal propensity to import out of absorption. When b& = b,, = 0, the portfolio balance schedule becomes steeper as assets become less perfect substitutes. A given balanced budget expansion will cause less loss of net foreign assets and more appre-
ciation. The higher the Q, the higher the risk premium, T; - F’,needed
to induce foreign investors to hold more domestic bonds. At the same time, the current account requires more appreciation because an ap- preciation only affects the trade balance; with initial asset stocks equal to zero, there are no service account effects generated by a change in the real exchange rate. Figure 7.2b illustrates the effects of a balanced budget expansion that is anticipated several periods before its occurrence. As soon as
the expansion is foreseen, the exchange rate appreciates to X I , as
investors expecting future increases in the domestic real interest rate raise their demands for domestic assets. Since the expansion has yet to materialize, the system follows the dynamics dictated by the original dynamic schedules and further appreciation occurs. In this region there is a current account deficit due to the appreciation, so net foreign assets decumulate over this period. The appreciation has a contractionary effect on the domestic economy, while demand increases abroad. To clear both goods markets, r declines while _r_* increases so that i - i* is negative and equal to the expected appreciation over the period. By the time of the implementation of the fiscal expansion, the economy has arrived at A2 on the stable trajectory to the new equilibrium. From then on the economy evolves as in the unanticipated case described above. With the fiscal expansion in place, r increases so that it exceeds _r_* until the new equilibrium is reached. When initial asset holdings are large enough to ensure that the current account balance schedule is upward-sloping, a balanced budget ex-
243 Expansionary Fiscal Policy and International InterdeDendence
X I n i o^ =O
A
X
B
I I I nfao nfo’ nfa
I nio=O
nfo, nfao nfo’ n f a Fig. 7. 3 BBE when^ R^ >^^0 and^ .4^ <^ Kd^ <^ 1.2.^ A,^ an unanticipated BBE. B , an anticipated BBE
Here, the new steady state is characterized by an appreciated real exchange rate and a higher level of net foreign assets. The new steady state exchange rate is higher when assets are less substitutable due to the familiar result that a@ - F*)/dfl > 0. As assets become less sub- stitutable, the interest rates in each country are freer to diverge from each other, so that they can bear more of the burden of equilibrating both goods markets. Given some degree of imperfect asset substitut- ability, the exchange rate is also higher when initial holdings of foreign assets are higher. In the new steady state, a positive relative return differential will have a negative impact on the service account because more debt service must be paid abroad, while less interest is received
244 Linda S. Kole
domestically. Therefore, for a given increase in g, less appreciation is necessary to eliminate the current account surplus due to crowding out of private domestic demand. In the long run, the trade balance suffers less deterioration, whereas the service account deteriorates by more as b& = b f , are increased.
When .4 < b&, < 1.2, the level of net foreign assets in the new steady
state is positively related to the degree of imperfect asset substituta- bility. As assets become less substitutable, the portfolio disequilibrium caused by a given change in the exchange rate grows larger. The fiscally induced appreciation causes investors to reshuffle their portfolios to- ward foreign bonds. Finally, the new steady state level of net foreign assets is negatively related to the initial foreign position of domestic investors. The higher b&, the more net debt service will flow abroad, increasing the tendency to decumulate net foreign assets. Next, we examine possible dynamic responses to a balanced budget expansion when initial foreign asset holdings are relatively large. Under this scenario, a balanced budget expansion shifts both schedules down and to the left. Here, the increase in government spending has a neg- ative impact on the current account; although the trade balance im- proves, the service account deteriorates by a larger amount. Therefore, either a decrease in net foreign assets and/or an appreciation is needed to restore current account balance. If domestic and foreign assets are perfect substitutes, the new long- run steady state is likely to be characterized by a lower real exchange rate as well as an increase in net foreign assets held domestically. The dynamic path to the new equilibrium is quite similar to that of figure 7.3a and is thus not shown here. However, the underlying dy- namics of the economy are quite different. The impact effect of the fiscal expansion is appreciation and an increase in interest rates, but the foreign interest rate increases by more than the domestic rate does. This increase in the relative return to foreign bonds improves the ser- vice account, and along with the direct crowding out due to the increase in g, outweighs the deterioration of the current account due to appre- ciation. Persistent current account surpluses generate net foreign asset accumulation for the domestic country while appreciation matching P
- P* maintains portfolio equilibrium. The domestic country ends up with a higher level of net foreign assets in the new steady state because of the service account surpluses experienced in the adjustment period. This result is in contrast to the usual loss of net foreign assets through persistent trade balance deficits following a permanent fiscal stimulus. The dynamics of an anticipated fiscal expansion in this case are shown in figure 7.4a. After a small appreciation of the exchange rate as soon as the expansionary policy is expected, the exchange rate appreciates while capital flows abroad. Initially, the domestic real in-
246 Linda S. Kole
sition period. Also, note that the higher the degree of imperfect asset substitutability and b&,, the more likely it is that there will be a long- run depreciation to restore current account balance.” Figure 7.4b shows the dynamic response to an anticipated balanced budget expansion for this case. The usual initial appreciation when the policy is announced coincides with a fall in r and an increase in _r_* to clear both goods markets. Before the policy comes into effect, the exchange rate con- tinues to appreciate to ensure portfolio balance while net foreign assets accumulate through service account surpluses. When the fiscal impetus occurs, the economy reaches _A,_* and there is a large jump in the domestic interest rate to eliminate excess demand at home. From then on, the current account is in deficit and depreciation accompanies cap- ital inflows.
Above, we have focused primarily on the parameters R and b&, while
ignoring the others in the system. Let us turn to a brief discussion of the other parameters. We will approach the analysis from a simplified angle by considering the case of perfect asset substitutability. A bal-
anced budget expansion in a nation with a higher marginal propensity
to save out of disposable income will lead to a higher real exchange rate and a lower level of net foreign assets in the new steady state. In the long run, disposable income is lower domestically and higher abroad. This causes a decrease in domestic absorption, which relieves pressure on the real exchange rate to crowd out the foreign component of de- mand. The higher the savings rate, the more of a decrease (increase) in savings will occur in the domestic (foreign) country. Over time, larger domestic current account deficits will lead to a lower long-run level of net foreign assets. The higher the absorption responsiveness of the trade balance, E, the lower thexand the higher the 5. A higher magnitude of E causes a given fiscal expansion to crowd out more domestic demand for foreign goods, and thus the real exchange rate must appreciate by more to ensure current account balance. The larger improvement in the trade balance also engenders a long-run gain in the net foreign asset position. The more elastic the trade balance with respect to the real exchange rate (the higher q), the less the real appreciation needed for current account balance. In the long run, the terms-of-trade elasticity is also positively related to the level of net foreign assets. An increase in the initial level of the real interest rate leads to a higher and a lower nfa. Due to the fiscally induced loss of service account income, there will be more of a tendency for net foreign asset decumulation, and current account balance will require a more com- petitive level of the real exchange rate. Finally, increases in 6 will be associated with further appreciation and more capital outflows in re- sponse to the increase in g. If absorption is more elastic with respect
247 Expansionary Fiscal Policy and International Interdependence
to wealth, long-run real appreciation has a more negative (positive) effect on domestic (foreign) absorption.18 Therefore, a lower x and higher nfa will be necessary to equilibrate the current account.
At this point, a comment on the simplifying assumptions employed
above is in order. In Kole (1984), the model was revised to account for output and price flexibility by including standard money demand equations and allowing price changes based on excess supply or de- mand. These changes resulted in a four by four dynamic model upon which simulations were performed. When output is allowed to deviate from its full employment level, the impact of fiscal expansion on the exchange rate and interest rates is reduced in magnitude, but the basic direction of movement remains the same. The adjustment process takes longer in the fuller model, probably because of the less dramatic nature of the events occurring in the initial periods following an expansion. Also, the assumption that the expanding country was initially neither a net debtor nor creditor was relaxed. It was shown that the debt situation is likely to deteriorate following a fiscal stimulus in a lender country if the initial level of debt is large and/or domestic and foreign bonds are imperfect substitutes. Under these conditions, the negative impact of increased world interest rates on a debtor nation’s service account far outweighs any trade balance improvement derived from the real depreciation of its currency.
7.4 A Bond-Financed Increase in Government Spending Next, we analyze the dynamic adjustment to a permanent increase in government spending which is originally financed by bond creation. For any given spending increase, there are unlimited combinations of 6, the target stock of outstanding bonds, and p, the rate of adjustment to that target, that are consistent with equation (10). We will look at two cases to examine what different dynamic and long-run effects can be expected as the rate of adjustment increases and the amount of bonds created decreases. The short-run effect of a bond financed fiscal expansion will be an increase in the domestic real interest rate and a discrete appreciation, both occurring to clear the home goods market. In general, the initial amount of appreciation and increase in the interest rate will be larger in magnitude than in the balanced budget case. In the initial period, domestic taxes increase to cover higher debt service, but the increase in government sending is entirely financed by the issuance of new domestic bonds. The budget deficit creates a larger initial boom in demand than that caused by a balanced budget expansion. Because
more crowding out is needed in the first period, X and r must move
by more.
