Liquidity Constraints, the Composition of Government Expenditure, and Economic Growth

Wenkai Sun () and Xianghong Wang

Global Economic Review, 2011, vol. 40, issue 4, 409-419

Abstract: This paper examines the impacts of liquidity constraints on economic growth and social welfare by incorporating the role of government expenditure into the overlapping-generations model developed by Jappelli and Pagano in 1990s. In our model, the government can provide funds to the young faced with liquidity constraints. Our theoretical findings are as follows: (1) with exogenous technical progress, liquidity constraints on households raise the saving rate; (2) with endogenous technical progress, liquidity constraints and economic growth rate show an inverted U-shaped relationship; (3) with both exogenous and endogenous technical progress, the steady state per capita income first increases and then declines with the increase of liquidity constraints. Our empirical analysis with cross-country data supported this conclusion; (4) given certain values of the model parameters, social welfare in steady state may decrease with the reduction of liquidity constraints.

Date: 2011
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DOI: 10.1080/1226508X.2011.626150

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