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Fiscal policy in a tractable liquidity-constrained economy

Edouard Challe () and Xavier Ragot ()

No 297, Sciences Po publications from Sciences Po

Abstract: In this paper, we analyse the effects of transitory fiscal expansions when public debt is used as liquidity by the private sector. Aggregate shocks are introduced into a tractable fexible-price, incomplete-market economy where heterogenous, infinitely-lived agents face occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic income fluctuations. Debt-financed increases in public spending facilitate self-insurance by bond holders and may crowd in private consumption. The implied higher stock of liquidity also loosens the borrowing constraints faced by .rms, thereby raising labour demand and possibly the real wage. Whether private consumption and wages actually rise or fall ultimately depends on the relative strengths of the liquidity and wealth effects that arise following the shock. The expansionary effects of tax cuts are also discussed.

Keywords: Borrowing constraints; Public debt; Fiscal policy shocks (search for similar items in EconPapers)
JEL-codes: E21 E62 (search for similar items in EconPapers)
Date: 2010-10
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Related works:
Journal Article: Fiscal Policy in a Tractable Liquidity‐Constrained Economy (2011) Downloads
Working Paper: Fiscal Policy in a Tractable Liquidity-Constrained Economy (2011)
Working Paper: Fiscal Policy in a Tractable Liquidity-Constrained Economy (2011)
Working Paper: Fiscal policy in a tractable liquidity - constrained economy (2011) Downloads
Working Paper: Fiscal Policy in a Tractable Liquidity-Constrained Economy (2010) Downloads
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