CONSEQUENCES OF DEBT POLICY IN A STOCHASTICALLY GROWING MONETARY ECONOMY

The effects of open-market operations and long-versus short-bond finan cing on risk in financial markets in a stochastically growing economy are studied. An increase in short bonds, resulting from exchanging lon g bonds, increases the riskiness of long bonds and raises their real r ate of return. An open-market purchase of either long or short bonds r aises the price of long bonds and lowers their risk and real return. H owever, debt policy adjustments that affect the real return to long bo nds do not affect real investment or growth, so that overall the welfa re consequences of debt policy are neutral.