WORKING PAPER SERIES

Government Debt, Output, and Asymmetric Information

Joseph H. Haslag and

D. C. Betts

Working Paper 1987-003A http://research.stlouisfed.org/wp/1987/1987-003.pdf

1987

FEDERAL RESERVE BANK OF ST. LOUIS Research Division 411 Locust Street

St. Louis, MO 63102 ______________________________________________________________________________________

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Federal Reserve Bank of St. Louis Working Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to Federal Reserve Bank of St. Louis Working Papers (other than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors.

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GOVEmfENT DEBT, OUTPUT, AND ASYMMETRIC INFORMATION

Joseph H . Haslag* and D. C . Betts*;k

F e d e r a l Reserve Bank of S t . Louis

87-003

Recent e x p l a n a t i o n of monetary p o l i c y and i t s e f f e c t have c e n t e r e d upon a non-cooperative game i n v o l v i n g t h e monetary a u t h o r i t y and t h e p r i v a t e s e c t o r . Notably a b s e n t from t h e d i s c u s s i o n of asymmetric i n f o r m a t i o n and i t s impact on d e c i s i o n making i s f i s c a l p o l i c y . Th is n o t e examines a s imple model where t h e f i s c a l a u t h o r i t y de te rmines t h e o p t i m a l r a t i o of permanent t o t o t a l government debt based on e x p l i c i t o p t i m i z i n g behav ior . D e f i c i t f i n a n c i n g can have shor t - run e f f e c t s because of u n c e r t a i n t y concerning f u t u r e f i s c a l p o l i c y . However, i n t h e long r u n , changes i n n e t p r i v a t e s e c t o r w e a l t h due t o government f i n a n c i n g p o l i c i e s do n o t a f f e c t p r i v a t e s e c t o r behav ior .

* Economist, F e d e r a l Reserve Bank of S t . Louis

** Southern Methodis t U n i v e r s i t y and U n i v e r s i t y of Texas a t Aus t i n

The a u t h o r s wish t o thank Nathan Balke, Michael Cox and Stephen McDonald f o r h e l p f u l comments. Any e r r o r s a r e , of c o u r s e , t h e r e s p o n s i b i l i t y of t h e a u t h o r s .

Th i s paper i s s u b j e c t t o r e v i s i o n and i s f o r review and comment. Not t o be quoted w i t h o u t t h e a u t h o r s ' pe rmiss ion .