Monetary and Fiscal Policy in an Optimizing Model with Capital Accumulation and Finite Lives

This paper considers the effects of monetary and fiscal policies in an optimizing model with capital accumulation and finite lives. An increase in monetary growth is no longer superneutral in a money-capital economy, but leads to a reduction in the real interest rate and increases in the capital stock, seignorage revenues, human wealth and total consumption. The effect on real money balances and social welfare is ambiguous. When open-market operations are used to increase monetary growth, there are no real effects unless preferences are non-separable in consumption of goods and real money balances. A tax-financed fiscal expansion increases the rate of interest, reduces the capital stock, real money balances and human and non-human wealth, and therefore crowds out consumption by more than 100 per cent. A bond-financed fiscal expansion increases capital by less and crowds out consumption by more than a money-financed fiscal expansion. None of the above policies affect the real interest rate, capital, total wealth and consumption when households are immortal.