Skip to main content

June/July 1980

Financing Constraints and the Short-Run Response to Fiscal Policy

by Laurence H. Meyer

This paper presents a framework for analyzing fiscal policy that incorporates the interaction between government and the private sector in their spending and borrowing decisions. It shows that ambiguity surrounding the income multiplier for increased government expenditures results from the failure to model correctly the stock repercussions of changes in government spending and private investment. Specifically, the ambiguity is caused by failure to allow for changes in the supply of capital (or private financial securities issued to finance the capital stock) that arise in response to debt-financed fiscal policy. When the analysis is amended to correctly incorporate the financing of private and public expenditures and to develop the relationship among saving, the deficit, and crowding out, the initial impact of an increase in government expenditure on aggregate demand and income is unambiguously positive.