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Liquidity and Inefficient Investment

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  • Hart, Oliver
  • Zingales, Luigi

Abstract

We study the role of fiscal policy in a complete markets model where the only friction is the non-pledgeability of human capital. We show that the competitive equilibrium is constrained inefficient, leading to too little risky investment. We also show that fiscal policy following a large negative shock can increase ex ante welfare. Finally, we show that if the government cannot commit to the promised level of fiscal intervention, the ex post optimal fiscal policy will be too small from an ex ante perspective.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9537.

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Date of creation: Jul 2013
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Handle: RePEc:cpr:ceprdp:9537

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Keywords: aggregate shocks; fiscal policy; liquidity; nonpledgeability; pecuniary externalities;

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  1. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  2. Olivier Jeanne & Anton Korinek, 2013. "Macroprudential Regulation Versus Mopping Up After the Crash," NBER Working Papers 18675, National Bureau of Economic Research, Inc.
  3. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
  4. Holmström, Bengt, 2011. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262015783, December.
  5. Hart, Oliver & Zingales, Luigi, 2011. "Inefficient Provision of Liquidity," CEPR Discussion Papers 8525, C.E.P.R. Discussion Papers.
  6. Ricardo J. Caballero & Arvind Krishnamurthy, 2009. "Global Imbalances and Financial Fragility," NBER Working Papers 14688, National Bureau of Economic Research, Inc.
  7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  8. Barro, Robert, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," Scholarly Articles 3208215, Harvard University Department of Economics.
  9. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  10. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
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