 PUBLIC DEBT UNDER LIMITED PRIVATE CREDITJournal of the European Economic Association, 2013, vol. 11, issue 2, 229-245 Abstract: There is a conventional wisdom in economics that public debt can serve as a substitute for private credit if private borrowing is limited. The purpose of this paper is to show that, while a government could in principle use such a policy to fully relax borrowing limits, this is not generally optimal. In our economy, agents invest in a short‐term asset, a long‐term asset, and government bonds. Agents are subject to idiosyncratic liquidity shocks prior to the maturity of the long‐term asset. We show that a high public debt policy fully relaxes private borrowing limits and is suboptimal. This is because agents expecting such a policy respond by investing less than is socially optimal in the short asset which can protect them in the event of a liquidity shock. The optimal policy is more constrained and it induces a wedge between the technological rate of return on the long asset and the rate of return on bonds. In such a regime, agents subject to liquidity shocks are also borrowing constrained, and this expectation of being borrowing constrained induces them to invest the optimal level in the short asset. Date: 2013 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:bla:jeurec:v:11:y:2013:i:2:p:229-245 Access Statistics for this article Journal of the European Economic Association is currently edited by Fabrizio Zilibotti, Dirk Bergemann, Nicola Gennaioli, Claudio Michelacci and Daniele Paserman More articles in Journal of the European Economic Association from European Economic Association Contact information at EDIRC. |
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