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Fiscal Policy in a Tractable Liquidity‐Constrained Economy

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  • Edouard Challe
  • Xavier Ragot

Abstract

We analyse the effects of fiscal expansions when public debt is used as liquidity by the private sector. Aggregate shocks are introduced into an incomplete-market economy where heterogenous agents face occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic income fluctuations. Debt‐financed increases in spending facilitate self‐insurance by bond holders and may crowd in private consumption. They also loosen the borrowing constraints faced by firms, thereby raising labour demand and possibly the real wage. Whether private consumption and wages rise or fall ultimately depends on the relative strengths of the liquidity and wealth effects that arise following the shock.

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File URL: http://hdl.handle.net/10.1111/j.1468-0297.2010.02399.x
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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 121 (2011)
Issue (Month): 551 (March)
Pages: 273-317

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Handle: RePEc:ecj:econjl:v:121:y:2011:i:551:p:273-317

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  1. Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 137-153, March.
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Cited by:
  1. Slim Bridji & Matthieu Charpe, 2012. "Labour Market and Fiscal Policy," IHEID Working Papers 03-2012, Economics Section, The Graduate Institute of International Studies, revised 16 Feb 2012.
  2. Edouard Challe & Xavier Ragot, 2010. "Aggregate Consumption in Times of Crisis: The Role of Financial Frictions -super-1," CESifo Economic Studies, CESifo, vol. 56(4), pages 627-648, December.
  3. George-Marios Angeletos & Fabrice Collard & Harris Dellas & Behzad Diba, 2013. "Optimal Public Debt Management and Liquidity Provision," NBER Working Papers 18800, National Bureau of Economic Research, Inc.
  4. Xavier Ragot & Edouard Challe, 2011. "Precautionary Saving over the Business Cycle," 2011 Meeting Papers 517, Society for Economic Dynamics.
  5. Real Arai & Takuma Kunieda & Keigo Nishida, 2014. "Is Public Debt Growth-Enhancing or Growth-Reducing?," KIER Working Papers 884, Kyoto University, Institute of Economic Research.

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