Abstract from Prof Eric Leeper's Guest Lecture presented at the Treasury on 21 August 2007.
Prof Eric Leeper
Eric Leeper is a professor of economics at Indiana University. His research focuses on theoretical and empirical models of macro policy. His theoretical work emphasizes that because policy choices are constrained by the government’s budget identity, monetary and fiscal policies interact dynamically in complicated ways. His recent work examines the implications of treating policy as fluctuating over time between different policy regimes. Another branch of Leeper’s research attempts to isolate exogenous changes in monetary policy and fiscal policy and to quantify their dynamic impacts on macroeconomic variables. Leeper has also researched how central banks that desire to be transparent can best achieve that objective. Leeper is the director of the Center for Applied Economics and Policy Research at Indiana University and a Research Associate at the National Bureau of Economic Research. He also serves as an external advisor to the Swedish central bank (Sveriges Riksbank) and is a regular visitor to the Federal Reserve Board and several Federal Reserve Banks. Leeper received a Ph.D. in economics from the University of Minnesota in 1989 and a B.S. in economics from George Mason University in 1980. Prior to joining the faculty at Indiana University in 1995, Leeper was a research officer in the macropolicy group at the Federal Reserve Bank of Atlanta and he spent four years as a staff economist in the International Finance Division of the Board of Governors. He was born in Isfahan, Iran, and spent his school-age years in Taiwan, Malaysia, Seattle, Hong Kong, and Northern Virginia.
Governments, like households and firms, do not have unlimited spending power: total government expenditures are constrained by total receipts–due to taxation or borrowing from the public. In abstract economic models, this is called “the government’s budget constraint.” Every model that purports to say something about macro policies–monetary or fiscal–must include such an object and its satisfaction is a condition of any equilibrium. Many theoretical applications make the budget constraint appear benign: non-distorting sources of revenues or spending are always available to ensure the constraint is satisfied without further complicating the analysis. In more realistic applications, however, the requirement that macro policies must satisfy the government budget constraint can dramatically alter the theoretical and empirical predictions of fiscal experiments. This lecture develops this line of reasoning, placing special emphasis on the dynamic–or intertemporal–aspects of fiscal financing. In the dynamic world in which we live, bond holders value government debt according to what they expect is the present value of future primary fiscal surpluses, producing the government’s intertemporal constraint. After developing the logical arguments, the lecture uses standard theory to demonstrate why in dynamic environments the government budget constraint can matter a great deal for the predicted effects of changes in fiscal policy. The lecture then briefly touches on some empirical findings regarding how U.S. government debt has been financed historically. The lecture concludes with some practical implications that should concern policy makers and policy analysts, pointing out that for some reason governments have opted to create institutional arrangements that treat the dynamic aspects of monetary and fiscal policies asymmetrically.