Interest Rates, Government Bond Sales, and the IS‐LM Model

T. Windsor Fields and William R. Hart
    The conventional wisdom is that interest rates, private investment, and real output are all affected by the government bond sales required to finance a budget deficit. Mainstream macroeconomic textbooks, however, imply no such effect. We demonstrate that the reason for this result is the absence of a financial wealth effect on money demand in the IS-LM model. When such an effect is included, bond sales turn out to have consequences that are consistent with conventional wisdom. In this paper, we sort through these issues, pointing out those areas where the discussion of the economic effects of government bond sales is confusing, incomplete, and, in some cases, incorrect.

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