Money, Debt, and Economic Activity.

The paper develops an alternative to the standard IS-LM framework. There are two asset markets and three prices--the prices of real assets, financial assets, and output. Costs of adjustment and information prevent output prices and output from adjusting instantaneously. Both the size of deficits and the method of financing affect output and prices. Some principal implications are derived. Several of these are also demonstrated, using a graph to show the interaction of asset markets, output markets, and the financing of the budget deficit. Some main implications of standard analysis are rejected. The basis for several "monetarist" conclusions is shown. The framework developed in this paper differs from the standard IS-LM framework, in severed principal ways. There are two asset markets and three prices--the prices of real assets, financial assets, and current output. Wealth owners are permitted to choose between money, bonds, real capital, and current expenditure. The real value of the outstanding stock of government debt does not equal the (discounted) present value of future tax liabilities. Costs of adjustment and cost of acquiring information prevent the output market from adjusting immediately. Excess demand or supply on the output market drives prices and output up or down but does not instantaneously restore equilibrium. Differences in the framework produce differences in implications. Some of the principal implications are stated in the introduction and discussed in our preliminary conclusion above. Others concern the transmission of fiscal and monetary policies, the role of the credit market in the determination of interest rates, and the determination of equilibrium and disequilibrium values for prices wad output. We discard the notion that fiscal policies work "directly" while monetary policies work "indirectly." Both types of policy change the relative prices of assets and output. Relative price changes set off a process of adjustment that conti... [ABSTRACT FROM AUTHOR]