The Stability of Bond Financed Deficits: A Critique of the Literature

31 Pages Posted: 5 Nov 2012

See all articles by Vivek Moorthy

Vivek Moorthy

Indian Institute of Management Bangalore

Date Written: September 30, 1998

Abstract

A large body of literature has concluded that bond finance of the deficit is unstable because of rising interest payments on the debt. This paper criticizes this literature in detail, focusing on the Blinder-Solow and Sargent-Wallace papers. It argues that conclusions regarding a debt trap under bond finance stem from unrealistic assumptions about the interest rate, and not from the assumption of budget balance in the Blinder- Solow model, as commonly believed. An adaptive expectations Fisher-equation specification for how interest rates respond to the mode of debt financing and to inflation, implies that, in a growth framework, stability under bond finance can be easily achieved.

JEL Classification: E42, E43, E63

Suggested Citation

Moorthy, Vivek, The Stability of Bond Financed Deficits: A Critique of the Literature (September 30, 1998). IIM Bangalore Research Paper No. 115, Available at SSRN: https://ssrn.com/abstract=2168061 or http://dx.doi.org/10.2139/ssrn.2168061

Vivek Moorthy (Contact Author)

Indian Institute of Management Bangalore ( email )

Bannerghatta Road
Bangalore, Karnataka 560076
India

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