The Liquidity Channel of Fiscal Policy

Benjamin Born, Christian Bayer and Ralph Luetticke

No 14883, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We provide evidence that expansionary fiscal policy lowers the return difference between public debt and less liquid assets---the liquidity premium. We rationalize this finding in an estimated heterogeneous-agent New-Keynesian model with incomplete markets and portfolio choice, in which public debt affects private liquidity. This liquidity channel stabilizes fixed-capital investment. We then quantify the long-run effects of higher public debt and find little crowding out of capital, but a sizable decline of the liquidity premium, which increases the fiscal burden of debt. We show that the revenue-maximizing level of public debt is positive and has increased to 60 percent of US GDP post-2010.

Keywords: Business cycles; Fiscal policy; Hank; Impulse response matching; Incomplete markets; Liquidity premium; Public debt (search for similar items in EconPapers)
JEL-codes: C11 D31 E21 E32 E63 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (10)

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Related works:
Journal Article: The liquidity channel of fiscal policy (2023)
Working Paper: The Liquidity Channel of Fiscal Policy (2021)
Working Paper: The Liquidity Channel of Fiscal Policy (2020)
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