Fiscal Policy in a Tractable Liquidity‐Constrained Economy

Édouard Challe · Xavier Ragot

61 citations0/0 files storedThe Economic Journal

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Economic theories and models Monetary Policy and Economic Impact Fiscal Policies and Political Economy

Abstract

In this paper, we analyse the effects of transitory fiscal expansions when public debt is used as liquidity by the private sector. Aggregate shocks are introduced into a tractable flexible-price, incomplete-market economy where heterogenous, infinitely-lived agents face occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic income fluctuations. Debt-financed increases in public spending facilitate self insurance by bond holders and may crowd in private consumption. The implied higher stock of liquidity also loosens the borrowing constraints faced by firms, thereby raising labour demand and possibly the real wage. Whether private consumption and wages actually rise or fall ultimately depends on the relative strengths of the liquidity and wealth effects that arise following the shock. The expansionary effects of tax cuts are also discussed.

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References

2005Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy 1997Credit Cycles 2002An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output 1994Uninsured Idiosyncratic Risk and Aggregate Saving 1998Income and Wealth Heterogeneity in the Macroeconomy 2007Understanding the Effects of Government Spending on Consumption 1998Private and Public Supply of Liquidity 1998The Behavior of U. S. Public Debt and Deficits

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