Open Access Journal Article

An overlapping generations version of Krugman’s world’s smallest macroeconomic model and fiscal deficit

by Yasuhito Tanaka a,* orcid
a
Faculty of Economics, Doshisha University, Kyoto, Japan
*
Author to whom correspondence should be addressed.
JEA  2024, 80; 3(4), 80; https://doi.org/10.58567/jea03040006
Received: 12 September 2023 / Accepted: 6 November 2023 / Published Online: 15 December 2024
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Abstract

This paper attempts to introduce an overlapping generations structure into Paul Krugman's "The world's smallest macroeconomic model" (Krugman (1999)) to examine the implications of fiscal policy, particularly fiscal deficits, in a framework suitable for policy analysis. In that paper, Krugman argued that under the price rigidity assumption, a shortage in the money supply leads to underemployment and recession, so increasing the money supply would eliminate underemployment and restore full employment. But how can the money supply be increased? I show that in order to restore full employment out of a recession, a fiscal deficit is needed to increase the money supply. I also show that in a growing economy, fiscal deficits are necessary to maintain full employment at constant prices or inflation. Fiscal deficits are not only effective in pulling the economy out of recession, they are even necessary for growth to continue without recession or inflation. The fiscal deficit in this paper represents the difference between government spending and government revenues. If this difference is positive, we say that the government is in deficit. Krugman's original model is a one-period static model. I intend to extend this model to a dynamic overlapping generations model.

Keywords: Fiscal deficit; full employment; price rigidity; growth; overlapping generations model;
Copyright: © 2024 by Tanaka. This is an open-access article distributed under the terms of the Creative Commons Attribution License (CC BY) (Creative Commons Attribution 4.0 International License). The use, distribution or reproduction in other forums is permitted, provided the original author(s) or licensor are credited and that the original publication in this journal is cited, in accordance with accepted academic practice. No use, distribution or reproduction is permitted which does not comply with these terms.

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ACS Style
Tanaka, Y. An overlapping generations version of Krugman’s world’s smallest macroeconomic model and fiscal deficit. Journal of Economic Analysis, 2024, 3, 80. https://doi.org/10.58567/jea03040006
AMA Style
Tanaka Y. An overlapping generations version of Krugman’s world’s smallest macroeconomic model and fiscal deficit. Journal of Economic Analysis; 2024, 3(4):80. https://doi.org/10.58567/jea03040006
Chicago/Turabian Style
Tanaka, Yasuhito 2024. "An overlapping generations version of Krugman’s world’s smallest macroeconomic model and fiscal deficit" Journal of Economic Analysis 3, no.4:80. https://doi.org/10.58567/jea03040006
APA style
Tanaka, Y. (2024). An overlapping generations version of Krugman’s world’s smallest macroeconomic model and fiscal deficit. Journal of Economic Analysis, 3(4), 80. https://doi.org/10.58567/jea03040006

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