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Fiscal Policy in a Tractable Liquidity-Constrained Economy

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  • Challe, E.
  • Ragot, X.

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 flexible-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 firms, 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. Classification-JEL: E21; E62.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 297.

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Length: 61 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bfr:banfra:297

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Web page: http://www.banque-france.fr/
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Related research

Keywords: Borrowing constraints; Public Debt; Fiscal Policy Shocks.;

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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. 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.
  2. 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.
  3. Xavier Ragot & Edouard Challe, 2011. "Precautionary Saving over the Business Cycle," 2011 Meeting Papers 517, Society for Economic Dynamics.
  4. 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.
  5. 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.

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