Excess sensitivity to targeted fiscal interventions in HANK models with zero liquidity

Yuichiro Waki

No 4823, MRG Discussion Paper Series from School of Economics, University of Queensland, Australia

Abstract: The zero liquidity assumption — nobody can borrow or lend in equilibrium because everyone faces a stringent borrowing constraint and because assets are in zero net supply — simplifies analyses of incomplete-market heterogeneousagents macroeconomic models, by making the equilibrium distribution of asset holdings degenerate. However, when combined with the heterogeneous-agents New Keynesian (HANK) models, this assumption implies that aggregate variables exhibit excess sensitivity to targeted fiscal interventions. Specifically, an arbitrarily large contraction of output can occur in response to an arbitrarily smallsized redistribution of income across households. Yet, at the same time, this result is fragile: by relaxing the households’ borrowing constraints, even slightly, the marginal intervention effect on output becomes finite, thereby eliminating the potential for small interventions to have large effects on output. Although the zero liquidity assumption makes HANK models tractable, it should be used with caution when redistribution of income is concerned.

Keywords: Heterogeneous agents; New Keynesian model; zero liquidity; fiscal policy; targeted fiscal intervention (search for similar items in EconPapers)
JEL-codes: D10 D15 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:qld:uqmrg6:48

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