Necessity of Budget Deficit Under Economic Growth in Monopolistic Competition

Abstract

The aim of the paper is to show, using a simple two-period overlapping generations model in which goods are produced solely by labour in a monopolistically competitive industry, that a continuous budget deficit (including the interest payments on government bonds) is necessary to achieve and maintain full employment under economic growth driven by technological progress. Since the budget deficits must be continuous, it might be better if they were financed by seigniorage rather than government debt. Since the budget deficit due to the issuance of government bonds puts pressure on fiscal expenditures in the amount of interest payments, a budget deficit of the same size due to seigniorage is a more effective use of the budget. It will also be shown that to achieve full employment from a recession with involuntary unemployment the extra budget deficit is necessary.