A Keynesian View of the Budget Deficit

The two instruments of macroeconomic management available to the government are fiscal policy and monetary policy. Together they determine the total dose of demand stimulus or restraint administered to the economy. In principle there are numerous mixtures of the two medicines which yield the same net stimulus or restraint of aggregate demand for goods and services. These various policy mixtures can differ significantly in their side effects. A tight budget, whose effects on aggregate demand are offset by an appropriately easy monetary policy, will bring lower interest rates than the opposite combination. Consequently, it will channel more of the nation's resources into domestic and foreign investment and relatively less into private and public consumption. The two issues—direction and size of total dose, and mix of the dose—are separable. Both are important issues today.