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Comment from an unreconstructed Ricardian
Journal of Monetary Economics 4 (1978) 569-581. © North-Holland Publishing Company
C O M M E N T F R O M AN U N R E C O N S T R U C T E D RICARDIAN Robert J. BARRO*
The Universityof Rochester, Rochester, NY 14627, U.S.A.
1. Introduction Buchanan and Wagner's thought-provoking new book, Democracy in Deficit: The Political Legacy of Lord Keynes, raises a number of interesting theoretical and empirical issues. I discuss, first, some aspects of public debt theory, second, the inconsistency between Buchanan and Wagner's major theme and the facts of public debt issue in the United States, third, empirical evidence from the U.S. on the relation between federal budget deficits and money creation, and fourth, the role of macroeconomic theory in analyses of fiscal and monetary policy.
2. Classical versus Keynesian and Ricardian versus non-Ricardian theories of public debt The present book and Buchanan's earlier works [for example (1958), (1967)] emphasize a distinction between classical and Keynesian theories of public debt. In fact, the classical approach as presented by Buchanan and Wagner (henceforth, B & W) appears identical in this respect to Keynesian analysis. The different conclusions on deficit finance that arise under B & W versions of classical and Keynesian models derive entirely from differing views on the determination of output and employment. 1 Both models begin with a rejection of Ricardian equivalence 2 by assu~ning that a shift from tax to debt finance, for a given level of current government spending, would lead to an increase in perceived private sector wealth and hence to an increase in aggregate demand. With the supply of commodities fixed in the classical setting at the 'full employment' *This work was supported by the National Science Foundation. The research was carried out while I was a National Fellow at the Hoover Institution. I am grateful to Jim Buchanan (1976) for pointing out my Ricardian heritage and thereby sugt~e~,~tingthe title of the present paper. 1In B & W's terminology (p. 20), differences in 'the theory of economic process.' ~I abstract here and below f. om the issue of whether Ricardo was a Ricardian, as discussed in O'Driscoll (1977).
570
R.J. Barro, An unreconstructed Ricardian
level, the restoration of market clearing requires a decrease in aggregate demand via increases in the price level and/or the rate of return. The reduction in capital accumulation implied by a higher rate of return implies lower future values of the capital,'labor ratio, which yields the I'uture burden of the debt in the sense of Modigliani (1961). Even without this capital stock reduction, the shift from current to future taxation could imply a shifting of the tax burden to later g e n e r a t i o n s - a s manifested for currently living generations in a transfer of lifetime disposable income from currently young to currently old individuals. This effect seems to constitute the burden of the debt on future generations in the sense of Buchanan (1958). The difference in a Keynesian setting is that the initial expansion in aggregate demand leads to increases in output as well as to increases in the price level and/or the rate of return. Given an initial state of ' u n d e r - p r o d u c t i o n ' - i n particular, a situation of 'excess supply" in the commodity and labor m a r k e t s the rise in output and employment means that current and future generations could conceivably all be better off because of the debt expansion. 3 Although the underlying theoretical basis for this type of Keynesian excess supply theory is questionable, the important point for present purposes is that the different results about debt burden in the Keynesian and classical models depend entirely on the different theories of output determination.'* The interesting dichotomy in public debt theory is that between Ricardian and non-Ricardian versions. In a Ricardian setting where the futme taxes implicit in the public debt are fully capitalized by current generations, the shift from tax to debt finance considered above would have no initial expansionary effect on aggregate demand. It is then immediate that the rise in the government deficit would have no (first-order) effect on the price level, rate of return, level of output, or the capital/labor ratio. Accordingly, there would be no burden of the public debt in a Ricardian setting. 5 aInvestment could rise in this case despite a higher rate of return because of an accelerator effect. The capital-labor ratio could also be increased in the long run, if one interprets 'long run' not as full employment, but as the average outcome in a 'suitable' stochastic Keynesian model that embodies fiscal policy as part of its structure. 4B & W are ambiguous on this point. On pp. 134-135 they say, '... the Keynesian policy principles which call for debt-financed budget deficits are based on an analytical model that purports to demonstrate that current taxation and public debt issue do exert differing effects on the behavior of individuals . . . . In this respect, we are strictly Keynesian, rather than Ricardian .... ' Hov~evcr, on p. 20, 'There is, of course, no necessary relationship between the theory of public debt and the theory of economic process. A sophisticated analysis can incorporate a strictly classical view of public debt into a predominantly Keynesian theory t~f income and employment.' But, using B & W's description of the 'classical view of public deb,~,' the last model would seem to be identical to the Keynesian model. 5Any shift from current to future taxation implied by debt issue does not involve a burden on later generations in :.his case because of the imp!icit connection- via operative private intergenerational transfers-between the old and the young. See Barro (1974, sectioa I), Buchanan (1967, p. 263), and Ricardo (1951, pp. 186-87). Second-order effects that concern such things as the timing of (non-lump-sum) taxation have not been considered here. The
R.I. Barro, An unreconstructed Ricardian
571
T h e R i c a r d i a n position is c o n t r o v e r s i a l on t h e o r e t i - a l and empirical g r o u n d s , a l t h o u g h the o p p o s i n g case has no firm s u p p o r t i n g evidence o f w h i c h I am aware. 6 T h e a p p a r e n t recent increase in respectability o f the R i c a r d i a n view as a theoretical p r o p o s i t i o n can be seen as a c o u n t e r p a r t o f the increasing use of the r a t i o n a l b e h a v i o r m o d e l in m a c r o e c o n o m i c s , as reflected especially in recent a p p r o a c h e s to e x p e c t a t i o n f o r m a t i o n . In t e r m s o f theoretical respectability, the R i c a r d i a n view o f public d e b t represents a m u c h more serious chaUenge to K e y n e s i a n fiscal activism t h a n previous discussions that focused on slopes o f I/S a n d L / M curves. In this respect I am entirely in a g r e e m e n t with B & W, w h o note (p. 137) ... it is surprising t h a t such an a t t a c k or challenge was not l a u n c h e d soon after K e y n e s i a n ideas were presented to e c o n o m i s t s . A l m o s t universally, e c o n o m i s t s a c c e p t e d the Keynesian p r o p o s i t i o n t h a t debt-financed deficits w o u l d increase total s p e n d i n g in the e c o n o m y . . . . G o v e r n m e n t debt i n s t r u m e n t s were treated as positively valued assets in the n a t i o n a l b a l a n c e sheet, but little or no attention was paid to the R i c a r d i a n notion t h a t the future tax p a y m e n t s e m b o d i e d in public debt may also represent liabilities. T h e r e was no early discussion. in s u p p o r t or in o p p o s i t i o n , of the h y p o t h e s i s that the possible efficacy o f fiscal policy depends on some sort of 'tiscal illusion.' M y main reaction is to share B & W ' s surprise t h a t fiscal policy discussions have not included the R i c a r d i a n equivalence p r o p o s i t i o n as a m a j o r point of debate. ~ F u t u r e theoretical and empirical in~,estigations on fiscal policy and the role o f public debt could usei'ully focus on the validity or invalidity o f this p r o p o s i t i o n . analysis also assumes that public debt and capitalized future taxes are perfect substitutes in portfolios, so that there are no effects on the demand for money, etc. The neutral effect of delicits can hold x~hether the Ricardian view of public debt is combined ~ith a classical or a Keynesian theory of economic process. In the latter case there is an is.,ue of whether any additional equilibria exist of the form: deficits make people feel wealthier and this perception is validated by the increased real income that results in a Keynesian setting because of the wealth-induced rise in aggregate demand. Such self-fulfilling-expectations equilibria would have to satisfy the stringent condition of coincidence between the increase in the present value of real income and the increase in perceived wealth. The neutral case satisfie~; this condition trivially, but ! an: uncertain whether any other equilibria can be found. In :,,ny case there x~oultl be no reason to associate equilibria of this sort with an expv.nsionary effect of delicits. The same story could be told in a Keynesian sct*.ing with deticits making people fccl poorer (a feeling that ~ould then be validated by decrea+,es in actual real income~, or x~id~ any force that produced an exogenous change in wealth perc,ptions. (The property that the mere expectation of enhanced wealth can lead to the creation of real income depends on ;.t central element of the Keynesian model ~ namely, the inelticient operation of the private economy prior to the exogenous shift in expectations.) +'Some empirical evidence on the role of government deb'~ in ,,,a,.ing functions is cot~tained in Tanner (1970), Kochin (1974), and David and Scadding (1974). The social security ar,~t saving literature is also pertit,.'nt to this issue- see, for example, Fcldstein (1974, 1977), Barro (1977a), Barro and MacDonald (1977), and Darby (1977). Barro (1977b) contains some evidence that involves a direct consideration of the debt creation process. 7The discussions in Tobin (1971, p. 91), Bailey (1962, pp. 75-77), and Mundell (1971) shoul,l be noted. However, these treatments do not seem to regard the Ricardian equivalence t.a>,c as empirically relevant, even as a first-order proposition.
572
R.J. Barro, An unreconstructed Rh'ardian
In the present book B & W's main attack on the Ricardian theorem involves what may be termed the 'uncertainty means underestimation' perspective on future tax liabilities. They argue (p. 17), 'At the time of the borrowing decision, the individ~:al citizen is not assigned a specific and determinate share of the fiscal liability that the public debt represents.' Further (p. 101), 'The person must form some judgment of just how he, personally, will fare from the surplus... As such future gains become more remote and less subject to personal control, however, there is strong evidence suggesting that such future circumstances tend to be neglected, with "out of sight, out of mind" being the common-sense statement of this principle.' (Italics a d d e d - references to the 'strong evidence' were not provided.) Still further (p. 130), 'will he not be as likely to overestimate as to underestimate his tax share? Underestimation is predicted because complexity has the effect of weakening the cost signals, of introducing illusion over and beyond uncertainty.' This line of argument is not convincing. If government deficits imply highly uncertain individual future tax liabilities - either because of uncertainty about future procedures for levying taxes or because of complexity in the requisite calculations- the first-order effect would seem to be that riskaverse individuals would weigh the c~pected future liabilities more heavily than otherwise. 8 That is, individuals would effectively reduce their perceived wealth when current taxes were replaced by debt issue. However, the conclusions would depend on the nature of insurance markets and would be reversed if individual future tax liabilities were sufficiently strongly correlated with individual filture incomes. The discussion also suggests a distinction between customary movements in the public debt (say, in response to war or recession) as opposed to unusual movements. Thcre is no obvious reason for the future tax liabilities associated with the former type of debt movement to be systematically underestimated. The possibility that the future tax consequences of the surprise movements in the public debt would be underestimated over some period is explored in a preliminary way in Barro (1977b, section "I). 3. The facts of public debt issue in the United States The major theme 9f B & W's book is that tile Keynesian approach to economic policy has shifted the basic outlook to,yard public debt. 'Until 1946 ... our fiscal practice xvas largely a consistent one, with budget surpluses being the normal rule, and with deficits emerging pr~imarily during periods of war and severe depression" (p. 14). "... budgets normally produced surpluses during peacetime, and these surpluses were used to retire the debt created during war emergencies" (p. 12). The philosophical basis for the shift av, ay from this policy Sin fact, this type of argument seems to be what Buchanan (1967, pp. 258-60) has in mind in an earlier model to explain why less than 100~ of public expenditure is financed by debt creation. In that model public debt issue is motivated by the existence of 'imperfect' private capital markets (pp. 257-58) and by the finite lives of individuals (pp. 262-63). The latter two issues are discussed in Barro (1974, sections I and II).
R.J. Barro, An unreconstructed Ricardian
573
is supposed to have emerged during the Depression: 'While the history of our fiscal practice did not change through 1946, fiscal theory began to change during the 1930s' (p. 14). B & W's description of debt behavior in the post-World W a r II period is indicated by the following: '... there were major differences between the 1920s and the 1950s. Passive deficits were accepted, even if there was extreme reluctance to utilize the budget actively to combat what proved to be relatively mild swings in the aggregate economy . . . . Public debt was not reduced in any way comparable to the previous postwar period' (pp. 45-46). The sharpest change is claimed to apply since the celebrated 1964 tax cut: 'After 1964, the United States embarked on a course of fiscal irresponsibility matched by no other period in its two-century history . . . . the federal government's budget swept onward and upward toward explosive heights, financed increasingly and disproportionately by deficits' (p. 49). The facts on federal debt do not accord with this description of events for the post-World War II period. Table 1 contains data for illustrative years on the 'publicly-held' stock of nominal (par value), interest-bearing federal debt. 9 This definition of public debt excludes holdings by the Federal Reserve and by federal agencies and trust funds. In particular, movements in the monetary base, which correspond in recent years primarily to changes in Federal Reserve assets, have been separated out from movements in interest-bearing debt. Column 1 of table I indicates the quantity of nominal debt, while column 2 expresses this amount in 'real' terms by dividing by the value of the GNP deflator. The most interesting figures would seem to be those in column 3, which indicate the ratio of nominal debt to nominal GNP. A first observation is that the d e b t - G N P ratio has declined drastically during the post-World War 1I period from a peak value of 1.07 in 1945, the iinal year of the ,~var, to a trough of 0.19 in 1974, before rising to 0.24 in 1976. (The increase in the ratio for 1975-76 appears to be mainly a reaction to the sharp doxvnturn in the economy see below.) The average rate of decline in the ratio is a surprisingly high 6.0 % per 3'ear from 1945 to 1974 (4.8~,, per year from 1945 to 1o76). ~° This decJine applies both before and after 1 9 6 4 - t h e average rate of decline in the ratio is 4.90,~ per year from 1948 to 1964 and 5.8'!,] per year from !964 to 1974. The post-World War II behavior of the d c b t - G N P ratio is strikingly similar to that after World War I and the Civil War. The ratio declined from a World War 1 peak of 0.26 in 1918 to a pro-Depression trough of 0.14 in 1 9 2 9 - a n average rate of dcdlne of 5.6"~, per year. The estimated Civil War peak of 0.24 '~I have limited con:,;ideration to the funded debt, which corresponds to B & W's discussion. It is sometimes argued that the capitalized value of anticipated future social security benetits less tax payments should be included as part of the public debt. Although this extension is interesting for some purposes, it is difficult to distinguish anticipated social security benefits and taxes from other types of anticipated government expenditures and receipts. 1°The rate of decline may be somew'hat overstated because the wartime price controls produced an artificially low reported price level for 1945. The average rate of decline in the /o per year (4.1 o, /o per year from 1948 to 1976). ratio from 1948 to 1974 was 5.3 °"
R.J. Barro, An unreconstructed Ricardian
574
Table 1 Values of government debt and expenditure for selected years. Federal Government Year
1860 1865 1867 1880 1902 1916 1918 1922 1929 1940 1945 1948 1956 1964 1974 1976
State & Local Government
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1"8)
B~r
B flP
B r[Py
G flPy
B~l
B~L/P
B.,dPy
G~**/Py
0.06 2.22 2.24 1.71 0.93 0.91 20.5 21.6 14.9 41.5 228.2 193.6 198.1 218.1 269.9 408.5
0.4 8.7 8.8 9.1 5.6 3.8 59.9 67.1 45.3 142.6 600.5 364.6 314.9 300.0 231.9 305.3
0.01 * 0.24* 0.23" 0.13 0.041 0.018 0.26 0.29 0.14 0.42 1.07 0.75 0.47 0.34 0.19 0.24
0.01 * 0.10" 0.04" 0.02 0.02 0.02 0.23 0.04 0.03 0.10 0.40 0.13 0.17 0.19 0.21 0.23
2.1 4.5 5.1 7.9 13.6 16.4 13.4 17.0 44.5 90.4 211.2 236.3
12.7 19.0 14.9 24.5 41.3 56.4 35.3 32.0 70.7 124.3 181.4 176.6
0.09 0.09 0.06 0.11 0.13 0.16 0.06 0.07 0.11 0.14 0.15 0.14
0.05 0.06*** 0.08 0.07 0.08 0.04 0.06 0.08 0.09 0.11 0.11
*Based on trend value of real GNP-see notes. **State and local government expenditure less transfers from the federal governmentsee notes. ***Value is for 1913.
Notes to table 1: B f is the end-of-year value (mid-year value before 1916) in billions of dollars of privately-held, interest-bearing public debt at nominal par value. The gross debt includes fully-guaranteed securities issued by the Federal Home Mortgage Corporation, Home Owners Loan Corporation, Reconstruction Finance Corporation, Commodity Credit Corporation, U.S. Housing Authority, and Federal Housing Administration. The amounts of these issues are significant from 1934-44. Non-interest-bearing debt has been excluded. The figures are net of holdings by the Federal Reserve and government agencies and trust funds. Sources: Before 1916, Historical Statistics of the U.S., Colonial Times to 1970, p. 1118. 1916-41:Banking attd Monetary Statistics, pp. 509-12 and issues of the Federal Reserve Bulletin (for holdings by the Federal Reserve). 1939-76: Economic Report of the President, 1970, p. 255, 1976, p. 253, 1977, pp. 274-75; Treasury Bulletin, June 1977, p. 68; Banking and Monetary Statistics 1941-70, 1976, pp. 868, 869, 882. P is the GNP deflator (1972 = 1.0). Sources: 1929-76: National htcome andProduct d('cout:,ts of the U.S., 1929-74, pp. 264, 349; Economic Repart of the President, 1977, p. 190. 1889-1928: based on figures in Long-Term Economic Growth, pp. 222-23, Series B61.1867-1888: based on Gallman's data received from Anna Schwartz. 1860-66: based on cost of living index compiled by N.Y. Federal Reserve Bank, as reported in Historical Statistics of the U.S., Colonial Times to 1970, p. 212. y is real GNP (1972 base). Sources: 1929-76: National hacome and Product Accounts of the U.S., 1929-74, pp. 6, 324; Economic Report of the President, 1977, p. 188. 1909-1928: based on figures in Long-Term Economic Growth, pp. 182-83, Series A2. 1889-1908: Ibid., Series AI. 1869-1888: based on Gallman's data received from Anna Schwartz. Figures for 1860, 1865 and 1867 correspond to the estimated trer~d of real GNP over the 1880-1914 period (which implies an annual growth rate of 0.0359 per year). Gs is total nominal federal expenditure. Sources: 1929-76: National htcome attd Product
R.J. Barro, An unreconstructed Ricardian
575
Accounts of the U.S., 1929-74, pp. 94, 339; Economic Rel~ort of the PreMdent, 1977, p. 271. 1879-1928: Firestone (1960), Table A-3. 1860-78: based on averages of fiscal year data from Historical Statistics of the U.S., Colonial Times to 1970, p. 1114. B~t is the end-of-year value in billions of dollars of net nominal state and local debt. Sources: 1916--76, U.S. Survey of Current Business, July 1977, p. 15; May 1970, p. 14; May 1969, pp. I 1, 12. The 1902 figure (applying to the middle of the year) is from Historical Statistics of the U.S., Cohmial Times to 1970, p. 1127. G~t is total nominal state and local government expenditure less transfers from the federal government to the state and local sector. Sources: 1929-76: National Income and Product Accounts of the U.S., 1929-74, pp. 108, 341; Economic Report of the President, 1977, p. 272. Figures for 1902, 1913 (included with the 1916 figures in the table), and 1922 are from Historical Statistics of the U.S., Colonial Times to 1970, p. 1127.
in 1865 was followed by a decline to a pre-World War I trough of 0.018 in 1916. The average rate of decline during this period was 5.1 ~/o per year. Therefore, instead of exhibiting the shift in structure after World War II that was claimed by B & W. the behavior of the debt-GNP ratio shows remarkable uniformity in the periods following the three major wars since 1860. The main reason that B & W reach a contrary conclusion is that they focus on nominal debt. rather than real debt. ~ As discussed by Klein "975), it does seem that the post-World Wa~ II period is characterized by a diflc:ent monetary and price level regime from that prevailing earlier. This shift appears to reflect a movcment away fi'om the gold standard- a system which effectivcly pegs at least the long-run movements in the domestic price level relative to a possible world trend- to a liat regime, which, if anything, specifies a long-run gro~vth rate of money and prices (as dictated by considerations of inflationary finance, costs of inflation, etc.). In particular, the relative long-run stability in the price level that prevailed before World War 11 has been replaced by a setting of chronic inllation. Accordingly, the examination ot" nominal debt data may be satisfactory for the pre-World War I1 period, but wottld not be useful alter the war. Movements in nominal debt along x~ith the price level, which merely maintain the real value of the outstanding debt. are inaccurately labeled as deficits in this analysis. However, this point raises the issue of whether inflation and money creation are properly treated as exogenous x~ith respect to government deficit policy. 1 examine this issue in the next section. ttlt does not follow tbat the real debt fell in the post-World War 11 period because of inflation. The evidence (noted belo~v) is that the anticipated rate of inflation has a one-to-one effect on the growth rate of nominal debt and, therefore, has no effect on the growth of real debt. However, unanticipated inflation would tend to lower the amount of real debt. Since B & W do not subtract holdings of debt by the Federal Reserve, they are also including monetary base movements with the changes in interest-bearing debt. Public debt held at Federal Reserve banks ro.~e from $24 billion in 1945 to $37 billion in 1964 and to $97 billion in 1976. (Federal Reserve Bulletin, Oct. 1977, p. A32" Banking and Ahmctary Statistics, I940-70, p. 882.) In some places (for example, on p. 181, the $7(~0 billion figure for the 1977 value of the national debt) they also do not net out holdings of public debt by federal agencies and trust funds. The anaounts in this category rose from $27 billion in 1945 to 558 billion in 1964 and to $147 billion in 1976. (Sources as above.)
576
R.J. Barro, An unreconstructed Ricardian
In another paper [Barro (1977b)], I have carried out a preliminary, year-byyear analysis of public debt creation in the United States since World War I. Those results suggest that the principal movements in publicly-held federal debt can be explained by three variables: (1) the movement in federal expenditure relative to 'normal', which captures, in particular, the strong response of debt issue to (temporary) wartime spending; (2) the movement in real G N P relative to trend, which captures the countercyclical response of debt issue; and (3) a one-to-one effect of the anticipated inflation rate on the growth rate of nominal debt. The debt creation process appears to be reasonably s t a b l e - i n the sense of con~.tant coefficients for expressing the effects on debt issue of the above three variables - over the post-World War I sample. For example, the sharp expansion of federal debt for 1975-76 emerges as a response of somewhat more than the usual size to the sharp contraction of output and to the high value of the anticipated rate of inflation. The results from this detailcd analysis of debt creation, which deny any significant shift since World War I in the countercyclical response of debt or in the reaction of debt to changes in federal spending, are consistent with the above observations on the uniformity of the long-term movements in the debt-GNP ratio during the three major post-war periods. My main conclusion is that a careful analysis of public debt movements in the United States indicates that there is no factual basis for B & W's major theme of a shift in recent years to a new type of expansionary debt policy. It follows that the strong upward movement since the Great Depression in the ratio of total federal spending to G N P (as shown in table 1, column 4) cannot be explained by a shift in the debt process that did not in fact occur. ~2 Correspondingly, the historical evidence does not support the idea that a constitutional check on budget deficits, as proposed by B & W in chapter 12, would limit the gro~vth of government. 4. Federal deficits and money creation As noted above, a case could be made for a shift in monetary structure from pre- to post-World War II. Since B & W's book does not deal with this interesting topic, I will limit considcration here to their proposition that - apparently under a fiat money regime of the sort applicable to the United States in the post-World War 1I p e r i o d - "... existing political and monetary institutions operate to make the supply of money increase in response to budget imbalance' [p. 59, see also Ch. 8 and Laidler and Parkin (1975, p. 796)]. This plausible hypothesis turns out to receive surprisingly little support from the U.S. monetary experience since 1941. ~2See B & W, pp. 21, 99, 103-05 for a claimed connection between the size of the federal government and the behavior of federal deficits. Data on state and local debt and expenditure are also shown in table 1, although the behavior of this sector is not a major topic of B & W's book (,see p. 57).
R.J. Barro, An unreconstructed Ricardian
577
Table 2 reports regressions using as a dependent variable the annual growth rate of money, DMt = l o g ( M t ) - l o g ( M t _ l ) , where M is an annual average of the M I definition of the money stock. The form of the equation corresponds to that used in a previous study of mine (1 q78). In this formulation the independent variables are the following: (1) two annual lag values of money growth, which pick up any persistence effects that are not captured by the other explanatory variables; (2) a cyclical variable, UN,_~ =- l o g [ U / ( l - U ) ] t - t , where U is Table 2 Estimated money growth rate equations.
DM,-2
UNt-1 FEDVt SURt
Sample
Constant
DM,_I
1941-76 (I)
0.082 (0.027) 0.095 (0.031) 0.072 (0.026)
0.41 (0.14) 0.60 (0.15) 0.33 (0.14)
0.21 0.026 0.072 (0.12) (0.009) (0.016) 0.00 0.027 (0.13) (0.010) 0.37 0.026 0.133 (0.14) (0.009) (0.034)
0.084 (0.029) 0.086 (0.032) 0.087 (0.025)
0.47 (0.16) 0.63 (0.16) 0.28 (0.15)
0.19 0.027 01073 (0.16) (0.010) (0.027) -0.06 0.024 (0.13) (0.011) 0.50 0.034 0.184 (0.17) (0.009) (0.044)
(2) (3)
1946-76 (4) (5) (6)
R 2
D.W.
0.77* 1.90
0.0147'*
- 0 . 2 4 0.70* 1.93 (0.09) 0.32 0.80* 1.86 (0.16)
0,0170"* 0.0141"*
0.60
1 . 7 8 0.0149
- 0 . 1 2 0.50 (0.16) 0.69 0.71 (0.23)
1 . 8 1 0.0167 1 . 7 9 0.0131
*taking account of the weighting scheme - see notes. **applicable to the 1946-76 period -see notes.
Notes: The dependent variable is DMt - log(M,/Mt_ 1), where M is an annual average of the MI definition of the money stock. S U R - nominal federal surplus/[(GNP deflator). (trend value of real GNP)]. Data on the nominal federal surplus (national income accounts basis) are from National hwome attd Product Accounts of the U.S., 1929-74, pp. 9% 340; U.S. Survo' of Current Business, July 1977, p. 31. Definitions and sources of other variables appear in the text and in Barro (1978). Observations from 1941-45 have been multiplied by 0.36 - see Barro (1978, section 1). D.W. is the Durbin-Watson Statistic. 6 is the standard-errorof-estimate.
the unemployment rate in the total labor force: and (3) real federal expenditure (FED) r,.,a,w~: -' " " - to normal, FEDVt =-log(FEDt) - [log(FED)i*, where [log (FED)]* is a distributed lag of current and lagged values of log(FED), using an adaptation coefficient of 0.2 per year. The new variable considered here is the nominal federal surplus (national income accounts basis), divided by the GNP deflator and expressed relative to a trend value of real GNP (see the notes to table 2). The B & W hypothesis is that this sort of variable, denoted by SUR, would have a negative effect on money creation.
578
R.J. Barro, An unreconstructed Ricardian
Results are reported for the 1941-76 period (with the World War II observations receiving a lower w e i g h t - see the notes to table 2) and for the 1946-76 period. The first equation in the table, which includes F E D Vt and excludes SURt and which applies to the 1941-76 period, is the one utilized in my previous study (1978). It shows the expected (significantly) positive response of D M t to both UNt_ ~ (c~untercyclical reaction) and F E D V t (response to tederal spending relative to normal). The second equation replaces FED V t by SURt. ~a The results show the expected (significantly) negative sign on the SURt variable, although the fit is inferior to that yielded by the first equation. The third equation, which includes FED V, and SURt simultaneously, demonstrates that the main explanatory powel from the state of the federal budget derives from the expenditure relative to normal variable and not from any independent information contributed by observation of the surplus. The se.me conclusion obtains if a lagged value of the surplus variable is used instead of (or in addition to) the contemporaneous value. Basically similar results apply to the 1946-76 period. In fact, the SURt variable is insignificant over this sample (table 3, line 5) even when the F E D V t variable is omitted. ~4 The above results suggest that the principal link from the federal budget to money creation in recent U.S. experience involves departures of federal spending from n o r m a l - e s p e c i a l l y the positive response to wartime spending and the negative reaction to post-war spending c u t s - rather than the surplus position (or the level of federal spending), per se. Hence, the link between budget deficits and money creation (and, hence, the rate of inflation) that was perceived by B & W does not seem to have been operative. ~ 13Th e exogeneity of S U R t - that is, independence of this var;able from the error term in the money growth equation-is doubtful on sevcrat grounds. First, the decision to finance expenditure by debt plus high-powered money (the deficit), rather than taxes, need not be independent of the decision to create money. Second, the surplus is responsive to current output, which would, in turn, be positively related to the error term in the money equation. The biases from these two forces for the estimated coefficient of the SURt variable would seem to be in opposite directions (negative in the li;st case and positive in the second). Because of these problems with the contemporaneous surplus variable, the impact of the lagged surplus variable (below) may be of interest. 14The lagged surplus variable is also insignificant in this case. The positive coefficients on the SURt variable in the equations where the FED Vt variable r. also included (lines 3 and 6) probably reflect the correlation of the SURf variable with current output (n. 13, above), if SUR, is replaced by S U R t - i in these cases the estimated coefficients of the surplus variable are close to zero. The same general conclusions that are described in the text obtain if all observations for the 1941-76 sample are weighted equally, if the samples are terminated in 1974, or if the samples being at a later date such as 1954. In the last case, the FEDVt variable is less significant than before (over 1954-76 with the SURt variable omitted, the estimated coefficient on FIZDV, is 0.18, standard error = 0.08) and the surplus variable remains unim. portant (vdth the FED Vt variable omitted, the estimated coefficient on SUR, is 0.03, s.e. = o.32). J~'ln an estimated price level equation [Barro (1978)], which focuses on the effects of anticipated and unanticipated movements in money, the fraction of output absorbed by federal purchases of goods and services does have a direct positive effect. This result is consistent with
R.J. Barro, An unreconstructed Ricardian
579
5. On the role of macroeconomic theory in policy analysis B & W complain properly about tile omission of political analysis from standard discussions of 'optimal' macro policy-[according to] 'orthodox normative economics.., the economist provides policy advice and ... does not bother with the transmission of this counsel through the processes of political choice' (p. ix). Untbrtunately, B & W seem to be suggesting the substitution of a political theory of aggregate policy that omits serious consideration of macroeconomic theory. They apparently feel that it is possible to analyze the record and impact of fiscal and monetary policy and to propose basic changes in political structure aimed at altering the policy process without specifying a (macroeconomic) theory of the determination of output, employment, etc." 'Our critique of Keynesianism is concentrated on its political presuppositions, not on its internal theoretical structure . . . . This allows us largely but not completely to circumvent the troublesome and sometimes complex analysis in modern macroeconomic and monetary theory' (p. 5). 'We are not interested here in examining either the logical coherence or the empirical validity of' the description of the national economy that is embodied in this most basic of Keynesian models' (p. 8 I). B & W's proposed constitutional amendment (Ch. 12) would require federal budget balance except under extraordinary circumstances. The desirability of this type of rule would seem to depend on the potential efficacy of countercyclical fiscal policy as a stabilization device (within an appropriate political environment that would perhaps also require a constitutional change). I believe that the theoretical and empirical case for the benefits of fiscal activism is, in fact, nonexistent. However, it seems more sensible to argue in favor of activist tiscal policy on the basis of a (perhaps erroneous) Keynesian macroeconomic theory than to argue that the choice of an underlying rule for fiscal management can be made without considering the validity or invalidity of competing macroeconomic theories. it is apparent that B & W (pp. 27-28) do not think much of the macroeconomic theory literature. They say, '[in] macroeconomics ... there is nothing akin to the "well-functioning market" which will produce optimally preferred results ... "The economy," in the Keynesian paradigm, is afloat without a rudder ... There is a necessary interventionist bias ... that is inherent in the paradigm itself ...' (p. 28). Although this description seems accurate for most of the Keynesian literature, it is hard to see why the interventionist bias should be inherent in the macroeconomic approach, per se. Macroeconomics deals merely B & W's discussion of the inflationary effect of an increasing relative size of the public sector (p. 70). However, the ratio of federal purchases of goods and services to GNP has actually declined substantially from 1968 to 1976 (from 0.12 to 0.08). Current and lagged values of (anticipated or unanticipated) growth in the public debt w'ere insignificant when added to the price level equation [Barro (1977b, section 3)].
580
R.J. Barro, An unreconstructed Rieardian
with manageable general 'equilibrium' analysis. The implications for interventionism depend on the specifics of underlying ingredients, such as the consistency of supply and demand functions with rational behavior; the e,qiciency of the market process in terms of price adjustment, information spread, and permissible contractual arrangements; the mechanics of expectation formation, etc. Notably, the recent literature on 'rational expectation,' monetary models [Lucas (1973), Sargent and Wallace (1975), Barro (1976)] 16 can be classed as macroeconomic theory that does not support interventionism. 17 M y principal observations on the role of macroeconomic theory in the present context are first, it ;s not useful to discuss fiscal and m o n e t a r y policy without a theory of mac,~,economic relationships: and second, while political considerations may also be important, the primary reason that Keynesian analysis provides p o o r policy prescriptions is that this analysis is bad macroeconomics. 161t appears that B & W (pp. 108-109, n. 1) also do not like the rational expectations literature. However, their statement, "[In] ... some rational expectations models ... there would be no output-employment effects of money-financed deficits, even in the short run,' does not distinguish between anticipated and unanticipated money movements. The business cycle effects of monetary shocks are, in fact, central to this literature. Interestingly, B & W's attack on rational expectation models selects out my work ('For an exposition by a true believer, of which there are several, see Robert J. Barro ...'), while Bob Lucas, who is clearly more 'guilty' than I in this context, is treated in uniformly favorable fashion (p. 154, n. 6; p. 170, n. 10; p. 182, n. 6). Given the validity of one of Stigler's Laws - that only the magnitude of publicity counts, with the sign being unimportant - I cannot really complain about this selectivity. ~Patinkin's (1965, Chs. IX-XII) classic macro analysis under full employment conditions also is not biased toward interventionism. However, the comparative static setting of that model makes it difficult to apply to structural policy analysis.
References Bailey, M.J., 1971, National income and the price level, 2nd ed. (McGraw Hill, New York). Barro, R.J., 1974, Are government bonds net wealth? Journal of Political Economy 82, Nov./ Dec., 1095-1117. Barro, R.J., 1976, Rational expectations and the role of monetary policy, Journal of Monetary Economics 2, Jan., 1-32. Barro, R.J., I977a, Social Security and private saving- Evidence from the U.S. time series, unpublished, April, forthcoming from American Enterprise Institute. Barro, R.J., 1977b, On the determination of the public debt, unpublished, Dec. Barro, R.J., 1978, Unanticipated money, output, and the price level in the United States, Journal of Political Economy, forthcoming. Barro, R.J. and G. MacDonald, 1977, Social Security and consumer spending in an international cross section, unpublished, Aug. Buchanan, J.M., 1958, Public principles of public debt (Irwin, Homewood, IL). Buchanan, J.M., 1967, Public finance in democratic process (University of N. Carolina Press, Chapel Hill). Buchanan, J.M., 1976, Barro on the Ricardian equivalence theorem, Journal of Political Economy 84, April, :.,37-342. Buchanan, J.M. and R. Wagner, 1977, Democracy in deficit: The political legacy of Lord Keynes (Academic Press, New York). Darby, M.R., 1977, The effects of Social Security on income and the capital stock, unpublished, July, forthcoming from American Enterprise Institute.
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581
David, P. and J. Scadding, 1974, Private savings: Ultrarationality, aggregation and 'Dennison's Law', Journal of Political Economy 83, March/April, 225-249. Feldstein, M.S., 1974, Social Security, induced retirement, and aggregate capital accumulation, Journal of Political Economy, 82, Sept./Oct., 905-926. Feldstein, M.S., 1977, Social Security and private savings: International evidence in an extended life cycle laodel, forthcoming in: M. Feldstein and R. Inman, eds., The economics of public services, an International Economic Association conference volume. Firestone, J.M., 1960, Federal receipts and expenditures during business cycles, 1879-1958 (Princeton University Press, Princeton). Klein, B., 1975, Our new monetary standard: The measurement and effects of price uncertainty, 1800-1973, Economic Inquiry 13, Dec., 461-484. Kochin, L., 1974, Are future taxes anticipated by consumers? Journal of Money, Credit, and Banking 6, Aug., 385-394. Laidler, D.E.W. and J.M. Parkin, 1975, Inflation- A survey, Economic Journal 85, Dec., 741-809. Lucas, R.E., 1973, Some international evidence on output-inflation tradeoffs, American Economic Review 63, June, 326-334. Modigliani, F., 1961, Long-run implications of alternative fiscal policies and the burden of the national debt, Economic Journal 71, Dec., 730-755. Mundell, R., 1971, Money, debt, and the rate of interest, in: R. Mundell, ed., Monetary theory (Goodyear, Pacific Palisades, CA). O'Driscoli, G.P., 1977, The Ricardian nonequivalence theorem, Journal of Political Economy 85, Feb., 207-210. Patinkin, D., 1965, Money, interest, and prices, 2nd ed. (Harper and Row, New York). Ricardo, D., 1951, Funding system, in: V. 4 of P. Sraffa, ed., The works and correspondence of David Ricardo (Cambridge University Press, Cambridge). Sargent, T.J. and N. Wallace, 1975, Rational expectations, the optimal monetary instrument and the optimal money supply rule, Journal of Political Economy 83, April, 241-254. Tanner, J.E., 1970, Empirical evidence on the short-run real balance effect in Canada, Journal of Money, Credit and Banking 2, Nov., 473-485. Tobin, J., 1971, Essays in economics, V. 1: Macroeconomics (North-Holland, Amsterdam).
C O M M E N T F R O M AN U N R E C O N S T R U C T E D RICARDIAN Robert J. BARRO*
The Universityof Rochester, Rochester, NY 14627, U.S.A.
1. Introduction Buchanan and Wagner's thought-provoking new book, Democracy in Deficit: The Political Legacy of Lord Keynes, raises a number of interesting theoretical and empirical issues. I discuss, first, some aspects of public debt theory, second, the inconsistency between Buchanan and Wagner's major theme and the facts of public debt issue in the United States, third, empirical evidence from the U.S. on the relation between federal budget deficits and money creation, and fourth, the role of macroeconomic theory in analyses of fiscal and monetary policy.
2. Classical versus Keynesian and Ricardian versus non-Ricardian theories of public debt The present book and Buchanan's earlier works [for example (1958), (1967)] emphasize a distinction between classical and Keynesian theories of public debt. In fact, the classical approach as presented by Buchanan and Wagner (henceforth, B & W) appears identical in this respect to Keynesian analysis. The different conclusions on deficit finance that arise under B & W versions of classical and Keynesian models derive entirely from differing views on the determination of output and employment. 1 Both models begin with a rejection of Ricardian equivalence 2 by assu~ning that a shift from tax to debt finance, for a given level of current government spending, would lead to an increase in perceived private sector wealth and hence to an increase in aggregate demand. With the supply of commodities fixed in the classical setting at the 'full employment' *This work was supported by the National Science Foundation. The research was carried out while I was a National Fellow at the Hoover Institution. I am grateful to Jim Buchanan (1976) for pointing out my Ricardian heritage and thereby sugt~e~,~tingthe title of the present paper. 1In B & W's terminology (p. 20), differences in 'the theory of economic process.' ~I abstract here and below f. om the issue of whether Ricardo was a Ricardian, as discussed in O'Driscoll (1977).
570
R.J. Barro, An unreconstructed Ricardian
level, the restoration of market clearing requires a decrease in aggregate demand via increases in the price level and/or the rate of return. The reduction in capital accumulation implied by a higher rate of return implies lower future values of the capital,'labor ratio, which yields the I'uture burden of the debt in the sense of Modigliani (1961). Even without this capital stock reduction, the shift from current to future taxation could imply a shifting of the tax burden to later g e n e r a t i o n s - a s manifested for currently living generations in a transfer of lifetime disposable income from currently young to currently old individuals. This effect seems to constitute the burden of the debt on future generations in the sense of Buchanan (1958). The difference in a Keynesian setting is that the initial expansion in aggregate demand leads to increases in output as well as to increases in the price level and/or the rate of return. Given an initial state of ' u n d e r - p r o d u c t i o n ' - i n particular, a situation of 'excess supply" in the commodity and labor m a r k e t s the rise in output and employment means that current and future generations could conceivably all be better off because of the debt expansion. 3 Although the underlying theoretical basis for this type of Keynesian excess supply theory is questionable, the important point for present purposes is that the different results about debt burden in the Keynesian and classical models depend entirely on the different theories of output determination.'* The interesting dichotomy in public debt theory is that between Ricardian and non-Ricardian versions. In a Ricardian setting where the futme taxes implicit in the public debt are fully capitalized by current generations, the shift from tax to debt finance considered above would have no initial expansionary effect on aggregate demand. It is then immediate that the rise in the government deficit would have no (first-order) effect on the price level, rate of return, level of output, or the capital/labor ratio. Accordingly, there would be no burden of the public debt in a Ricardian setting. 5 aInvestment could rise in this case despite a higher rate of return because of an accelerator effect. The capital-labor ratio could also be increased in the long run, if one interprets 'long run' not as full employment, but as the average outcome in a 'suitable' stochastic Keynesian model that embodies fiscal policy as part of its structure. 4B & W are ambiguous on this point. On pp. 134-135 they say, '... the Keynesian policy principles which call for debt-financed budget deficits are based on an analytical model that purports to demonstrate that current taxation and public debt issue do exert differing effects on the behavior of individuals . . . . In this respect, we are strictly Keynesian, rather than Ricardian .... ' Hov~evcr, on p. 20, 'There is, of course, no necessary relationship between the theory of public debt and the theory of economic process. A sophisticated analysis can incorporate a strictly classical view of public debt into a predominantly Keynesian theory t~f income and employment.' But, using B & W's description of the 'classical view of public deb,~,' the last model would seem to be identical to the Keynesian model. 5Any shift from current to future taxation implied by debt issue does not involve a burden on later generations in :.his case because of the imp!icit connection- via operative private intergenerational transfers-between the old and the young. See Barro (1974, sectioa I), Buchanan (1967, p. 263), and Ricardo (1951, pp. 186-87). Second-order effects that concern such things as the timing of (non-lump-sum) taxation have not been considered here. The
R.I. Barro, An unreconstructed Ricardian
571
T h e R i c a r d i a n position is c o n t r o v e r s i a l on t h e o r e t i - a l and empirical g r o u n d s , a l t h o u g h the o p p o s i n g case has no firm s u p p o r t i n g evidence o f w h i c h I am aware. 6 T h e a p p a r e n t recent increase in respectability o f the R i c a r d i a n view as a theoretical p r o p o s i t i o n can be seen as a c o u n t e r p a r t o f the increasing use of the r a t i o n a l b e h a v i o r m o d e l in m a c r o e c o n o m i c s , as reflected especially in recent a p p r o a c h e s to e x p e c t a t i o n f o r m a t i o n . In t e r m s o f theoretical respectability, the R i c a r d i a n view o f public d e b t represents a m u c h more serious chaUenge to K e y n e s i a n fiscal activism t h a n previous discussions that focused on slopes o f I/S a n d L / M curves. In this respect I am entirely in a g r e e m e n t with B & W, w h o note (p. 137) ... it is surprising t h a t such an a t t a c k or challenge was not l a u n c h e d soon after K e y n e s i a n ideas were presented to e c o n o m i s t s . A l m o s t universally, e c o n o m i s t s a c c e p t e d the Keynesian p r o p o s i t i o n t h a t debt-financed deficits w o u l d increase total s p e n d i n g in the e c o n o m y . . . . G o v e r n m e n t debt i n s t r u m e n t s were treated as positively valued assets in the n a t i o n a l b a l a n c e sheet, but little or no attention was paid to the R i c a r d i a n notion t h a t the future tax p a y m e n t s e m b o d i e d in public debt may also represent liabilities. T h e r e was no early discussion. in s u p p o r t or in o p p o s i t i o n , of the h y p o t h e s i s that the possible efficacy o f fiscal policy depends on some sort of 'tiscal illusion.' M y main reaction is to share B & W ' s surprise t h a t fiscal policy discussions have not included the R i c a r d i a n equivalence p r o p o s i t i o n as a m a j o r point of debate. ~ F u t u r e theoretical and empirical in~,estigations on fiscal policy and the role o f public debt could usei'ully focus on the validity or invalidity o f this p r o p o s i t i o n . analysis also assumes that public debt and capitalized future taxes are perfect substitutes in portfolios, so that there are no effects on the demand for money, etc. The neutral effect of delicits can hold x~hether the Ricardian view of public debt is combined ~ith a classical or a Keynesian theory of economic process. In the latter case there is an is.,ue of whether any additional equilibria exist of the form: deficits make people feel wealthier and this perception is validated by the increased real income that results in a Keynesian setting because of the wealth-induced rise in aggregate demand. Such self-fulfilling-expectations equilibria would have to satisfy the stringent condition of coincidence between the increase in the present value of real income and the increase in perceived wealth. The neutral case satisfie~; this condition trivially, but ! an: uncertain whether any other equilibria can be found. In :,,ny case there x~oultl be no reason to associate equilibria of this sort with an expv.nsionary effect of delicits. The same story could be told in a Keynesian sct*.ing with deticits making people fccl poorer (a feeling that ~ould then be validated by decrea+,es in actual real income~, or x~id~ any force that produced an exogenous change in wealth perc,ptions. (The property that the mere expectation of enhanced wealth can lead to the creation of real income depends on ;.t central element of the Keynesian model ~ namely, the inelticient operation of the private economy prior to the exogenous shift in expectations.) +'Some empirical evidence on the role of government deb'~ in ,,,a,.ing functions is cot~tained in Tanner (1970), Kochin (1974), and David and Scadding (1974). The social security ar,~t saving literature is also pertit,.'nt to this issue- see, for example, Fcldstein (1974, 1977), Barro (1977a), Barro and MacDonald (1977), and Darby (1977). Barro (1977b) contains some evidence that involves a direct consideration of the debt creation process. 7The discussions in Tobin (1971, p. 91), Bailey (1962, pp. 75-77), and Mundell (1971) shoul,l be noted. However, these treatments do not seem to regard the Ricardian equivalence t.a>,c as empirically relevant, even as a first-order proposition.
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R.J. Barro, An unreconstructed Rh'ardian
In the present book B & W's main attack on the Ricardian theorem involves what may be termed the 'uncertainty means underestimation' perspective on future tax liabilities. They argue (p. 17), 'At the time of the borrowing decision, the individ~:al citizen is not assigned a specific and determinate share of the fiscal liability that the public debt represents.' Further (p. 101), 'The person must form some judgment of just how he, personally, will fare from the surplus... As such future gains become more remote and less subject to personal control, however, there is strong evidence suggesting that such future circumstances tend to be neglected, with "out of sight, out of mind" being the common-sense statement of this principle.' (Italics a d d e d - references to the 'strong evidence' were not provided.) Still further (p. 130), 'will he not be as likely to overestimate as to underestimate his tax share? Underestimation is predicted because complexity has the effect of weakening the cost signals, of introducing illusion over and beyond uncertainty.' This line of argument is not convincing. If government deficits imply highly uncertain individual future tax liabilities - either because of uncertainty about future procedures for levying taxes or because of complexity in the requisite calculations- the first-order effect would seem to be that riskaverse individuals would weigh the c~pected future liabilities more heavily than otherwise. 8 That is, individuals would effectively reduce their perceived wealth when current taxes were replaced by debt issue. However, the conclusions would depend on the nature of insurance markets and would be reversed if individual future tax liabilities were sufficiently strongly correlated with individual filture incomes. The discussion also suggests a distinction between customary movements in the public debt (say, in response to war or recession) as opposed to unusual movements. Thcre is no obvious reason for the future tax liabilities associated with the former type of debt movement to be systematically underestimated. The possibility that the future tax consequences of the surprise movements in the public debt would be underestimated over some period is explored in a preliminary way in Barro (1977b, section "I). 3. The facts of public debt issue in the United States The major theme 9f B & W's book is that tile Keynesian approach to economic policy has shifted the basic outlook to,yard public debt. 'Until 1946 ... our fiscal practice xvas largely a consistent one, with budget surpluses being the normal rule, and with deficits emerging pr~imarily during periods of war and severe depression" (p. 14). "... budgets normally produced surpluses during peacetime, and these surpluses were used to retire the debt created during war emergencies" (p. 12). The philosophical basis for the shift av, ay from this policy Sin fact, this type of argument seems to be what Buchanan (1967, pp. 258-60) has in mind in an earlier model to explain why less than 100~ of public expenditure is financed by debt creation. In that model public debt issue is motivated by the existence of 'imperfect' private capital markets (pp. 257-58) and by the finite lives of individuals (pp. 262-63). The latter two issues are discussed in Barro (1974, sections I and II).
R.J. Barro, An unreconstructed Ricardian
573
is supposed to have emerged during the Depression: 'While the history of our fiscal practice did not change through 1946, fiscal theory began to change during the 1930s' (p. 14). B & W's description of debt behavior in the post-World W a r II period is indicated by the following: '... there were major differences between the 1920s and the 1950s. Passive deficits were accepted, even if there was extreme reluctance to utilize the budget actively to combat what proved to be relatively mild swings in the aggregate economy . . . . Public debt was not reduced in any way comparable to the previous postwar period' (pp. 45-46). The sharpest change is claimed to apply since the celebrated 1964 tax cut: 'After 1964, the United States embarked on a course of fiscal irresponsibility matched by no other period in its two-century history . . . . the federal government's budget swept onward and upward toward explosive heights, financed increasingly and disproportionately by deficits' (p. 49). The facts on federal debt do not accord with this description of events for the post-World War II period. Table 1 contains data for illustrative years on the 'publicly-held' stock of nominal (par value), interest-bearing federal debt. 9 This definition of public debt excludes holdings by the Federal Reserve and by federal agencies and trust funds. In particular, movements in the monetary base, which correspond in recent years primarily to changes in Federal Reserve assets, have been separated out from movements in interest-bearing debt. Column 1 of table I indicates the quantity of nominal debt, while column 2 expresses this amount in 'real' terms by dividing by the value of the GNP deflator. The most interesting figures would seem to be those in column 3, which indicate the ratio of nominal debt to nominal GNP. A first observation is that the d e b t - G N P ratio has declined drastically during the post-World War 1I period from a peak value of 1.07 in 1945, the iinal year of the ,~var, to a trough of 0.19 in 1974, before rising to 0.24 in 1976. (The increase in the ratio for 1975-76 appears to be mainly a reaction to the sharp doxvnturn in the economy see below.) The average rate of decline in the ratio is a surprisingly high 6.0 % per 3'ear from 1945 to 1974 (4.8~,, per year from 1945 to 1o76). ~° This decJine applies both before and after 1 9 6 4 - t h e average rate of decline in the ratio is 4.90,~ per year from 1948 to 1964 and 5.8'!,] per year from !964 to 1974. The post-World War II behavior of the d c b t - G N P ratio is strikingly similar to that after World War I and the Civil War. The ratio declined from a World War 1 peak of 0.26 in 1918 to a pro-Depression trough of 0.14 in 1 9 2 9 - a n average rate of dcdlne of 5.6"~, per year. The estimated Civil War peak of 0.24 '~I have limited con:,;ideration to the funded debt, which corresponds to B & W's discussion. It is sometimes argued that the capitalized value of anticipated future social security benetits less tax payments should be included as part of the public debt. Although this extension is interesting for some purposes, it is difficult to distinguish anticipated social security benefits and taxes from other types of anticipated government expenditures and receipts. 1°The rate of decline may be somew'hat overstated because the wartime price controls produced an artificially low reported price level for 1945. The average rate of decline in the /o per year (4.1 o, /o per year from 1948 to 1976). ratio from 1948 to 1974 was 5.3 °"
R.J. Barro, An unreconstructed Ricardian
574
Table 1 Values of government debt and expenditure for selected years. Federal Government Year
1860 1865 1867 1880 1902 1916 1918 1922 1929 1940 1945 1948 1956 1964 1974 1976
State & Local Government
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1"8)
B~r
B flP
B r[Py
G flPy
B~l
B~L/P
B.,dPy
G~**/Py
0.06 2.22 2.24 1.71 0.93 0.91 20.5 21.6 14.9 41.5 228.2 193.6 198.1 218.1 269.9 408.5
0.4 8.7 8.8 9.1 5.6 3.8 59.9 67.1 45.3 142.6 600.5 364.6 314.9 300.0 231.9 305.3
0.01 * 0.24* 0.23" 0.13 0.041 0.018 0.26 0.29 0.14 0.42 1.07 0.75 0.47 0.34 0.19 0.24
0.01 * 0.10" 0.04" 0.02 0.02 0.02 0.23 0.04 0.03 0.10 0.40 0.13 0.17 0.19 0.21 0.23
2.1 4.5 5.1 7.9 13.6 16.4 13.4 17.0 44.5 90.4 211.2 236.3
12.7 19.0 14.9 24.5 41.3 56.4 35.3 32.0 70.7 124.3 181.4 176.6
0.09 0.09 0.06 0.11 0.13 0.16 0.06 0.07 0.11 0.14 0.15 0.14
0.05 0.06*** 0.08 0.07 0.08 0.04 0.06 0.08 0.09 0.11 0.11
*Based on trend value of real GNP-see notes. **State and local government expenditure less transfers from the federal governmentsee notes. ***Value is for 1913.
Notes to table 1: B f is the end-of-year value (mid-year value before 1916) in billions of dollars of privately-held, interest-bearing public debt at nominal par value. The gross debt includes fully-guaranteed securities issued by the Federal Home Mortgage Corporation, Home Owners Loan Corporation, Reconstruction Finance Corporation, Commodity Credit Corporation, U.S. Housing Authority, and Federal Housing Administration. The amounts of these issues are significant from 1934-44. Non-interest-bearing debt has been excluded. The figures are net of holdings by the Federal Reserve and government agencies and trust funds. Sources: Before 1916, Historical Statistics of the U.S., Colonial Times to 1970, p. 1118. 1916-41:Banking attd Monetary Statistics, pp. 509-12 and issues of the Federal Reserve Bulletin (for holdings by the Federal Reserve). 1939-76: Economic Report of the President, 1970, p. 255, 1976, p. 253, 1977, pp. 274-75; Treasury Bulletin, June 1977, p. 68; Banking and Monetary Statistics 1941-70, 1976, pp. 868, 869, 882. P is the GNP deflator (1972 = 1.0). Sources: 1929-76: National htcome andProduct d('cout:,ts of the U.S., 1929-74, pp. 264, 349; Economic Repart of the President, 1977, p. 190. 1889-1928: based on figures in Long-Term Economic Growth, pp. 222-23, Series B61.1867-1888: based on Gallman's data received from Anna Schwartz. 1860-66: based on cost of living index compiled by N.Y. Federal Reserve Bank, as reported in Historical Statistics of the U.S., Colonial Times to 1970, p. 212. y is real GNP (1972 base). Sources: 1929-76: National hacome and Product Accounts of the U.S., 1929-74, pp. 6, 324; Economic Report of the President, 1977, p. 188. 1909-1928: based on figures in Long-Term Economic Growth, pp. 182-83, Series A2. 1889-1908: Ibid., Series AI. 1869-1888: based on Gallman's data received from Anna Schwartz. Figures for 1860, 1865 and 1867 correspond to the estimated trer~d of real GNP over the 1880-1914 period (which implies an annual growth rate of 0.0359 per year). Gs is total nominal federal expenditure. Sources: 1929-76: National htcome attd Product
R.J. Barro, An unreconstructed Ricardian
575
Accounts of the U.S., 1929-74, pp. 94, 339; Economic Rel~ort of the PreMdent, 1977, p. 271. 1879-1928: Firestone (1960), Table A-3. 1860-78: based on averages of fiscal year data from Historical Statistics of the U.S., Colonial Times to 1970, p. 1114. B~t is the end-of-year value in billions of dollars of net nominal state and local debt. Sources: 1916--76, U.S. Survey of Current Business, July 1977, p. 15; May 1970, p. 14; May 1969, pp. I 1, 12. The 1902 figure (applying to the middle of the year) is from Historical Statistics of the U.S., Cohmial Times to 1970, p. 1127. G~t is total nominal state and local government expenditure less transfers from the federal government to the state and local sector. Sources: 1929-76: National Income and Product Accounts of the U.S., 1929-74, pp. 108, 341; Economic Report of the President, 1977, p. 272. Figures for 1902, 1913 (included with the 1916 figures in the table), and 1922 are from Historical Statistics of the U.S., Colonial Times to 1970, p. 1127.
in 1865 was followed by a decline to a pre-World War I trough of 0.018 in 1916. The average rate of decline during this period was 5.1 ~/o per year. Therefore, instead of exhibiting the shift in structure after World War II that was claimed by B & W. the behavior of the debt-GNP ratio shows remarkable uniformity in the periods following the three major wars since 1860. The main reason that B & W reach a contrary conclusion is that they focus on nominal debt. rather than real debt. ~ As discussed by Klein "975), it does seem that the post-World Wa~ II period is characterized by a diflc:ent monetary and price level regime from that prevailing earlier. This shift appears to reflect a movcment away fi'om the gold standard- a system which effectivcly pegs at least the long-run movements in the domestic price level relative to a possible world trend- to a liat regime, which, if anything, specifies a long-run gro~vth rate of money and prices (as dictated by considerations of inflationary finance, costs of inflation, etc.). In particular, the relative long-run stability in the price level that prevailed before World War 11 has been replaced by a setting of chronic inllation. Accordingly, the examination ot" nominal debt data may be satisfactory for the pre-World War I1 period, but wottld not be useful alter the war. Movements in nominal debt along x~ith the price level, which merely maintain the real value of the outstanding debt. are inaccurately labeled as deficits in this analysis. However, this point raises the issue of whether inflation and money creation are properly treated as exogenous x~ith respect to government deficit policy. 1 examine this issue in the next section. ttlt does not follow tbat the real debt fell in the post-World War 11 period because of inflation. The evidence (noted belo~v) is that the anticipated rate of inflation has a one-to-one effect on the growth rate of nominal debt and, therefore, has no effect on the growth of real debt. However, unanticipated inflation would tend to lower the amount of real debt. Since B & W do not subtract holdings of debt by the Federal Reserve, they are also including monetary base movements with the changes in interest-bearing debt. Public debt held at Federal Reserve banks ro.~e from $24 billion in 1945 to $37 billion in 1964 and to $97 billion in 1976. (Federal Reserve Bulletin, Oct. 1977, p. A32" Banking and Ahmctary Statistics, I940-70, p. 882.) In some places (for example, on p. 181, the $7(~0 billion figure for the 1977 value of the national debt) they also do not net out holdings of public debt by federal agencies and trust funds. The anaounts in this category rose from $27 billion in 1945 to 558 billion in 1964 and to $147 billion in 1976. (Sources as above.)
576
R.J. Barro, An unreconstructed Ricardian
In another paper [Barro (1977b)], I have carried out a preliminary, year-byyear analysis of public debt creation in the United States since World War I. Those results suggest that the principal movements in publicly-held federal debt can be explained by three variables: (1) the movement in federal expenditure relative to 'normal', which captures, in particular, the strong response of debt issue to (temporary) wartime spending; (2) the movement in real G N P relative to trend, which captures the countercyclical response of debt issue; and (3) a one-to-one effect of the anticipated inflation rate on the growth rate of nominal debt. The debt creation process appears to be reasonably s t a b l e - i n the sense of con~.tant coefficients for expressing the effects on debt issue of the above three variables - over the post-World War I sample. For example, the sharp expansion of federal debt for 1975-76 emerges as a response of somewhat more than the usual size to the sharp contraction of output and to the high value of the anticipated rate of inflation. The results from this detailcd analysis of debt creation, which deny any significant shift since World War I in the countercyclical response of debt or in the reaction of debt to changes in federal spending, are consistent with the above observations on the uniformity of the long-term movements in the debt-GNP ratio during the three major post-war periods. My main conclusion is that a careful analysis of public debt movements in the United States indicates that there is no factual basis for B & W's major theme of a shift in recent years to a new type of expansionary debt policy. It follows that the strong upward movement since the Great Depression in the ratio of total federal spending to G N P (as shown in table 1, column 4) cannot be explained by a shift in the debt process that did not in fact occur. ~2 Correspondingly, the historical evidence does not support the idea that a constitutional check on budget deficits, as proposed by B & W in chapter 12, would limit the gro~vth of government. 4. Federal deficits and money creation As noted above, a case could be made for a shift in monetary structure from pre- to post-World War II. Since B & W's book does not deal with this interesting topic, I will limit considcration here to their proposition that - apparently under a fiat money regime of the sort applicable to the United States in the post-World War 1I p e r i o d - "... existing political and monetary institutions operate to make the supply of money increase in response to budget imbalance' [p. 59, see also Ch. 8 and Laidler and Parkin (1975, p. 796)]. This plausible hypothesis turns out to receive surprisingly little support from the U.S. monetary experience since 1941. ~2See B & W, pp. 21, 99, 103-05 for a claimed connection between the size of the federal government and the behavior of federal deficits. Data on state and local debt and expenditure are also shown in table 1, although the behavior of this sector is not a major topic of B & W's book (,see p. 57).
R.J. Barro, An unreconstructed Ricardian
577
Table 2 reports regressions using as a dependent variable the annual growth rate of money, DMt = l o g ( M t ) - l o g ( M t _ l ) , where M is an annual average of the M I definition of the money stock. The form of the equation corresponds to that used in a previous study of mine (1 q78). In this formulation the independent variables are the following: (1) two annual lag values of money growth, which pick up any persistence effects that are not captured by the other explanatory variables; (2) a cyclical variable, UN,_~ =- l o g [ U / ( l - U ) ] t - t , where U is Table 2 Estimated money growth rate equations.
DM,-2
UNt-1 FEDVt SURt
Sample
Constant
DM,_I
1941-76 (I)
0.082 (0.027) 0.095 (0.031) 0.072 (0.026)
0.41 (0.14) 0.60 (0.15) 0.33 (0.14)
0.21 0.026 0.072 (0.12) (0.009) (0.016) 0.00 0.027 (0.13) (0.010) 0.37 0.026 0.133 (0.14) (0.009) (0.034)
0.084 (0.029) 0.086 (0.032) 0.087 (0.025)
0.47 (0.16) 0.63 (0.16) 0.28 (0.15)
0.19 0.027 01073 (0.16) (0.010) (0.027) -0.06 0.024 (0.13) (0.011) 0.50 0.034 0.184 (0.17) (0.009) (0.044)
(2) (3)
1946-76 (4) (5) (6)
R 2
D.W.
0.77* 1.90
0.0147'*
- 0 . 2 4 0.70* 1.93 (0.09) 0.32 0.80* 1.86 (0.16)
0,0170"* 0.0141"*
0.60
1 . 7 8 0.0149
- 0 . 1 2 0.50 (0.16) 0.69 0.71 (0.23)
1 . 8 1 0.0167 1 . 7 9 0.0131
*taking account of the weighting scheme - see notes. **applicable to the 1946-76 period -see notes.
Notes: The dependent variable is DMt - log(M,/Mt_ 1), where M is an annual average of the MI definition of the money stock. S U R - nominal federal surplus/[(GNP deflator). (trend value of real GNP)]. Data on the nominal federal surplus (national income accounts basis) are from National hwome attd Product Accounts of the U.S., 1929-74, pp. 9% 340; U.S. Survo' of Current Business, July 1977, p. 31. Definitions and sources of other variables appear in the text and in Barro (1978). Observations from 1941-45 have been multiplied by 0.36 - see Barro (1978, section 1). D.W. is the Durbin-Watson Statistic. 6 is the standard-errorof-estimate.
the unemployment rate in the total labor force: and (3) real federal expenditure (FED) r,.,a,w~: -' " " - to normal, FEDVt =-log(FEDt) - [log(FED)i*, where [log (FED)]* is a distributed lag of current and lagged values of log(FED), using an adaptation coefficient of 0.2 per year. The new variable considered here is the nominal federal surplus (national income accounts basis), divided by the GNP deflator and expressed relative to a trend value of real GNP (see the notes to table 2). The B & W hypothesis is that this sort of variable, denoted by SUR, would have a negative effect on money creation.
578
R.J. Barro, An unreconstructed Ricardian
Results are reported for the 1941-76 period (with the World War II observations receiving a lower w e i g h t - see the notes to table 2) and for the 1946-76 period. The first equation in the table, which includes F E D Vt and excludes SURt and which applies to the 1941-76 period, is the one utilized in my previous study (1978). It shows the expected (significantly) positive response of D M t to both UNt_ ~ (c~untercyclical reaction) and F E D V t (response to tederal spending relative to normal). The second equation replaces FED V t by SURt. ~a The results show the expected (significantly) negative sign on the SURt variable, although the fit is inferior to that yielded by the first equation. The third equation, which includes FED V, and SURt simultaneously, demonstrates that the main explanatory powel from the state of the federal budget derives from the expenditure relative to normal variable and not from any independent information contributed by observation of the surplus. The se.me conclusion obtains if a lagged value of the surplus variable is used instead of (or in addition to) the contemporaneous value. Basically similar results apply to the 1946-76 period. In fact, the SURt variable is insignificant over this sample (table 3, line 5) even when the F E D V t variable is omitted. ~4 The above results suggest that the principal link from the federal budget to money creation in recent U.S. experience involves departures of federal spending from n o r m a l - e s p e c i a l l y the positive response to wartime spending and the negative reaction to post-war spending c u t s - rather than the surplus position (or the level of federal spending), per se. Hence, the link between budget deficits and money creation (and, hence, the rate of inflation) that was perceived by B & W does not seem to have been operative. ~ 13Th e exogeneity of S U R t - that is, independence of this var;able from the error term in the money growth equation-is doubtful on sevcrat grounds. First, the decision to finance expenditure by debt plus high-powered money (the deficit), rather than taxes, need not be independent of the decision to create money. Second, the surplus is responsive to current output, which would, in turn, be positively related to the error term in the money equation. The biases from these two forces for the estimated coefficient of the SURt variable would seem to be in opposite directions (negative in the li;st case and positive in the second). Because of these problems with the contemporaneous surplus variable, the impact of the lagged surplus variable (below) may be of interest. 14The lagged surplus variable is also insignificant in this case. The positive coefficients on the SURt variable in the equations where the FED Vt variable r. also included (lines 3 and 6) probably reflect the correlation of the SURf variable with current output (n. 13, above), if SUR, is replaced by S U R t - i in these cases the estimated coefficients of the surplus variable are close to zero. The same general conclusions that are described in the text obtain if all observations for the 1941-76 sample are weighted equally, if the samples are terminated in 1974, or if the samples being at a later date such as 1954. In the last case, the FEDVt variable is less significant than before (over 1954-76 with the SURt variable omitted, the estimated coefficient on FIZDV, is 0.18, standard error = 0.08) and the surplus variable remains unim. portant (vdth the FED Vt variable omitted, the estimated coefficient on SUR, is 0.03, s.e. = o.32). J~'ln an estimated price level equation [Barro (1978)], which focuses on the effects of anticipated and unanticipated movements in money, the fraction of output absorbed by federal purchases of goods and services does have a direct positive effect. This result is consistent with
R.J. Barro, An unreconstructed Ricardian
579
5. On the role of macroeconomic theory in policy analysis B & W complain properly about tile omission of political analysis from standard discussions of 'optimal' macro policy-[according to] 'orthodox normative economics.., the economist provides policy advice and ... does not bother with the transmission of this counsel through the processes of political choice' (p. ix). Untbrtunately, B & W seem to be suggesting the substitution of a political theory of aggregate policy that omits serious consideration of macroeconomic theory. They apparently feel that it is possible to analyze the record and impact of fiscal and monetary policy and to propose basic changes in political structure aimed at altering the policy process without specifying a (macroeconomic) theory of the determination of output, employment, etc." 'Our critique of Keynesianism is concentrated on its political presuppositions, not on its internal theoretical structure . . . . This allows us largely but not completely to circumvent the troublesome and sometimes complex analysis in modern macroeconomic and monetary theory' (p. 5). 'We are not interested here in examining either the logical coherence or the empirical validity of' the description of the national economy that is embodied in this most basic of Keynesian models' (p. 8 I). B & W's proposed constitutional amendment (Ch. 12) would require federal budget balance except under extraordinary circumstances. The desirability of this type of rule would seem to depend on the potential efficacy of countercyclical fiscal policy as a stabilization device (within an appropriate political environment that would perhaps also require a constitutional change). I believe that the theoretical and empirical case for the benefits of fiscal activism is, in fact, nonexistent. However, it seems more sensible to argue in favor of activist tiscal policy on the basis of a (perhaps erroneous) Keynesian macroeconomic theory than to argue that the choice of an underlying rule for fiscal management can be made without considering the validity or invalidity of competing macroeconomic theories. it is apparent that B & W (pp. 27-28) do not think much of the macroeconomic theory literature. They say, '[in] macroeconomics ... there is nothing akin to the "well-functioning market" which will produce optimally preferred results ... "The economy," in the Keynesian paradigm, is afloat without a rudder ... There is a necessary interventionist bias ... that is inherent in the paradigm itself ...' (p. 28). Although this description seems accurate for most of the Keynesian literature, it is hard to see why the interventionist bias should be inherent in the macroeconomic approach, per se. Macroeconomics deals merely B & W's discussion of the inflationary effect of an increasing relative size of the public sector (p. 70). However, the ratio of federal purchases of goods and services to GNP has actually declined substantially from 1968 to 1976 (from 0.12 to 0.08). Current and lagged values of (anticipated or unanticipated) growth in the public debt w'ere insignificant when added to the price level equation [Barro (1977b, section 3)].
580
R.J. Barro, An unreconstructed Rieardian
with manageable general 'equilibrium' analysis. The implications for interventionism depend on the specifics of underlying ingredients, such as the consistency of supply and demand functions with rational behavior; the e,qiciency of the market process in terms of price adjustment, information spread, and permissible contractual arrangements; the mechanics of expectation formation, etc. Notably, the recent literature on 'rational expectation,' monetary models [Lucas (1973), Sargent and Wallace (1975), Barro (1976)] 16 can be classed as macroeconomic theory that does not support interventionism. 17 M y principal observations on the role of macroeconomic theory in the present context are first, it ;s not useful to discuss fiscal and m o n e t a r y policy without a theory of mac,~,economic relationships: and second, while political considerations may also be important, the primary reason that Keynesian analysis provides p o o r policy prescriptions is that this analysis is bad macroeconomics. 161t appears that B & W (pp. 108-109, n. 1) also do not like the rational expectations literature. However, their statement, "[In] ... some rational expectations models ... there would be no output-employment effects of money-financed deficits, even in the short run,' does not distinguish between anticipated and unanticipated money movements. The business cycle effects of monetary shocks are, in fact, central to this literature. Interestingly, B & W's attack on rational expectation models selects out my work ('For an exposition by a true believer, of which there are several, see Robert J. Barro ...'), while Bob Lucas, who is clearly more 'guilty' than I in this context, is treated in uniformly favorable fashion (p. 154, n. 6; p. 170, n. 10; p. 182, n. 6). Given the validity of one of Stigler's Laws - that only the magnitude of publicity counts, with the sign being unimportant - I cannot really complain about this selectivity. ~Patinkin's (1965, Chs. IX-XII) classic macro analysis under full employment conditions also is not biased toward interventionism. However, the comparative static setting of that model makes it difficult to apply to structural policy analysis.
References Bailey, M.J., 1971, National income and the price level, 2nd ed. (McGraw Hill, New York). Barro, R.J., 1974, Are government bonds net wealth? Journal of Political Economy 82, Nov./ Dec., 1095-1117. Barro, R.J., 1976, Rational expectations and the role of monetary policy, Journal of Monetary Economics 2, Jan., 1-32. Barro, R.J., I977a, Social Security and private saving- Evidence from the U.S. time series, unpublished, April, forthcoming from American Enterprise Institute. Barro, R.J., 1977b, On the determination of the public debt, unpublished, Dec. Barro, R.J., 1978, Unanticipated money, output, and the price level in the United States, Journal of Political Economy, forthcoming. Barro, R.J. and G. MacDonald, 1977, Social Security and consumer spending in an international cross section, unpublished, Aug. Buchanan, J.M., 1958, Public principles of public debt (Irwin, Homewood, IL). Buchanan, J.M., 1967, Public finance in democratic process (University of N. Carolina Press, Chapel Hill). Buchanan, J.M., 1976, Barro on the Ricardian equivalence theorem, Journal of Political Economy 84, April, :.,37-342. Buchanan, J.M. and R. Wagner, 1977, Democracy in deficit: The political legacy of Lord Keynes (Academic Press, New York). Darby, M.R., 1977, The effects of Social Security on income and the capital stock, unpublished, July, forthcoming from American Enterprise Institute.
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David, P. and J. Scadding, 1974, Private savings: Ultrarationality, aggregation and 'Dennison's Law', Journal of Political Economy 83, March/April, 225-249. Feldstein, M.S., 1974, Social Security, induced retirement, and aggregate capital accumulation, Journal of Political Economy, 82, Sept./Oct., 905-926. Feldstein, M.S., 1977, Social Security and private savings: International evidence in an extended life cycle laodel, forthcoming in: M. Feldstein and R. Inman, eds., The economics of public services, an International Economic Association conference volume. Firestone, J.M., 1960, Federal receipts and expenditures during business cycles, 1879-1958 (Princeton University Press, Princeton). Klein, B., 1975, Our new monetary standard: The measurement and effects of price uncertainty, 1800-1973, Economic Inquiry 13, Dec., 461-484. Kochin, L., 1974, Are future taxes anticipated by consumers? Journal of Money, Credit, and Banking 6, Aug., 385-394. Laidler, D.E.W. and J.M. Parkin, 1975, Inflation- A survey, Economic Journal 85, Dec., 741-809. Lucas, R.E., 1973, Some international evidence on output-inflation tradeoffs, American Economic Review 63, June, 326-334. Modigliani, F., 1961, Long-run implications of alternative fiscal policies and the burden of the national debt, Economic Journal 71, Dec., 730-755. Mundell, R., 1971, Money, debt, and the rate of interest, in: R. Mundell, ed., Monetary theory (Goodyear, Pacific Palisades, CA). O'Driscoli, G.P., 1977, The Ricardian nonequivalence theorem, Journal of Political Economy 85, Feb., 207-210. Patinkin, D., 1965, Money, interest, and prices, 2nd ed. (Harper and Row, New York). Ricardo, D., 1951, Funding system, in: V. 4 of P. Sraffa, ed., The works and correspondence of David Ricardo (Cambridge University Press, Cambridge). Sargent, T.J. and N. Wallace, 1975, Rational expectations, the optimal monetary instrument and the optimal money supply rule, Journal of Political Economy 83, April, 241-254. Tanner, J.E., 1970, Empirical evidence on the short-run real balance effect in Canada, Journal of Money, Credit and Banking 2, Nov., 473-485. Tobin, J., 1971, Essays in economics, V. 1: Macroeconomics (North-Holland, Amsterdam).