Fiscal policy in a tractable liquidity - constrained economy

Edouard Challe (1) , Xavier Ragot (2)

1 OFCE - Observatoire français des conjonctures économiques (Sciences Po)
2 ECON - Département d'économie (Sciences Po)

We analyse the effects of fiscal expansions when public debt is used as liquidity by the private sector.Aggregate shocks are introduced into an incomplete-market economy where heterogenous agentsface occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic incomefluctuations. Debt-financed increases in spending facilitate self-insurance by bond holders and maycrowd in private consumption. They also loosen the borrowing constraints faced by firms, therebyraising labour demand and possibly the real wage. Whether private consumption and wages rise orfall ultimately depends on the relative strengths of the liquidity and wealth effects that arise followingthe shock.

Keywords: Fiscal expansion; Public debt; Private sector; Private consumption

Domains: Economics and Finance

Edouard Challe, Xavier Ragot. Fiscal policy in a tractable liquidity - constrained economy: Constrained economy. The Economic Journal, 2011, 121 (551), pp.273 - 317. ⟨10.1111/j.1468-0297.2010.02399.x⟩. ⟨hal-03473791⟩