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The Liquidity Channel of Fiscal Policy

Christian Bayer (), Benjamin Born and Ralph Luetticke ()

No 351, ifo Working Paper Series from ifo Institute - Leibniz Institute for Economic Research at the University of Munich

Abstract: We provide evidence that expansionary fiscal policy lowers return differences 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 GDP post-2010.

Keywords: Business cycles; fiscal policy; HANK; 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: 2021
New Economics Papers: this item is included in nep-cwa, nep-dge and nep-mac
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Related works:
Working Paper: The Liquidity Channel of Fiscal Policy (2020) Downloads
Working Paper: The Liquidity Channel of Fiscal Policy (2020) Downloads
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