IDEAS home Printed from https://ideas.repec.org/p/arx/papers/2501.17458.html

Monetary-Fiscal Interaction and the Liquidity of Government Debt

Author

Listed:
  • Cristiano Cantore
  • Edoardo Leonardi

Abstract

How does the monetary and fiscal policy mix alter households' saving incentives? To answer these questions, we build a heterogenous agents New Keynesian model where three different types of agents can save in assets with different liquidity profiles to insure against idiosyncratic risk. Policy mixes affect saving incentives differently according to their effect on the liquidity premium -- the return difference between less liquid assets and public debt. We derive an intuitive analytical expression linking the liquidity premium with consumption differentials amongst different types of agents. This underscores the presence of a transmission mechanism through which the interaction of monetary and fiscal policy shapes economic stability via its effect on the portfolio choice of private agents. We call it the 'self-insurance demand channel', which moves the liquidity premium in the opposite direction to the standard 'policy-driven supply channel'. Our analysis thus reveals the presence of two competing forces driving the liquidity premium. We show that the relative strength of the two is tightly linked to the policy mix in place and the type of business cycle shock hitting the economy. This implies that to stabilize the economy, monetary policy should consider the impact of the 'self-insurance' on the liquidity premium.

Suggested Citation

  • Cristiano Cantore & Edoardo Leonardi, 2025. "Monetary-Fiscal Interaction and the Liquidity of Government Debt," Papers 2501.17458, arXiv.org.
    • Handle: RePEc:arx:papers:2501.17458
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/2501.17458
    File Function: Latest version
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Adrien Auclert & Matthew Rognlie & Ludwig Straub, 2024. "The Intertemporal Keynesian Cross," Journal of Political Economy, University of Chicago Press, vol. 132(12), pages 4068-4121.
    2. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," American Economic Review, American Economic Association, vol. 101(3), pages 471-475, May.
    3. Bayer, Christian & Born, Benjamin & Luetticke, Ralph, 2023. "The liquidity channel of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 134(C), pages 86-117.
    4. Cantore, Cristiano & Freund, Lukas B., 2021. "Workers, capitalists, and the government: fiscal policy and income (re)distribution," Journal of Monetary Economics, Elsevier, vol. 119(C), pages 58-74.
    5. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
    6. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    7. Kurt Mitman & Iourii Manovskii & Marcus Hagedorn, 2017. "The Fiscal Multiplier," 2017 Meeting Papers 1383, Society for Economic Dynamics.
    8. Bilbiie, Florin O. & Känzig, Diego R. & Surico, Paolo, 2022. "Capital and income inequality: An aggregate-demand complementarity," Journal of Monetary Economics, Elsevier, vol. 126(C), pages 154-169.
    9. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-388, May.
    10. Bilbiie, F. & Primiceri, G. E. & Tambalotti, A., 2022. "Inequality and Business Cycles," Cambridge Working Papers in Economics 2275, Faculty of Economics, University of Cambridge.
    11. Cristiano Cantore & Vedanta Dhamija, 2024. "The Perils of a Dual Mandate," Economics Series Working Papers 1059, University of Oxford, Department of Economics.
    12. Jacob D Orchard & Valerie A Ramey & Johannes F Wieland, 2025. "Micro MPCs and Macro Counterfactuals: The Case of the 2008 Rebates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 140(3), pages 2001-2052.
    13. repec:cam:camjip:2420 is not listed on IDEAS
    14. Greg Kaplan & Benjamin Moll & Giovanni L. Violante, 2018. "Monetary Policy According to HANK," American Economic Review, American Economic Association, vol. 108(3), pages 697-743, March.
    15. Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 227-270, March.
    16. Florin O Bilbiie, 2025. "Monetary Policy and Heterogeneity: An Analytical Framework," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 92(4), pages 2398-2436.
    17. Davig, Troy & Leeper, Eric M., 2011. "Monetary-fiscal policy interactions and fiscal stimulus," European Economic Review, Elsevier, vol. 55(2), pages 211-227, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Macaulay, Alistair, 2021. "The attention trap: Rational inattention, inequality, and fiscal policy," European Economic Review, Elsevier, vol. 135(C).
    2. Adrien Auclert & Ludwig Straub & Matthew Rognlie, 2019. "Micro Jumps, Macro Humps: monetary policy and business cycles in an estimated HANK model," 2019 Meeting Papers 1449, Society for Economic Dynamics.
    3. Zheng Gong, 2025. "When Does Household Heterogeneity Matter for Aggregate Fluctuations?," CRC TR 224 Discussion Paper Series crctr224_2025_624v2, University of Bonn and University of Mannheim, Germany, revised Sep 2025.
    4. repec:cam:camjip:2507 is not listed on IDEAS
    5. Cantore, Cristiano & Freund, Lukas B., 2021. "Workers, capitalists, and the government: fiscal policy and income (re)distribution," Journal of Monetary Economics, Elsevier, vol. 119(C), pages 58-74.
    6. Bartal, Mehdi & Becard, Yvan, 2024. "Consumption tax cuts vs stimulus payments," Journal of Public Economics, Elsevier, vol. 239(C).
    7. repec:bon:boncrc:crctr224_2025_624 is not listed on IDEAS
    8. Bilbiie, Florin O. & Monacelli, Tommaso & Perotti, Roberto, 2024. "Stabilization vs. Redistribution: The optimal monetary–fiscal mix," Journal of Monetary Economics, Elsevier, vol. 147(S).
    9. Bayer, Christian & Born, Benjamin & Luetticke, Ralph, 2023. "The liquidity channel of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 134(C), pages 86-117.
    10. Kopiec, Paweł, 2022. "The government spending multiplier in the Heterogeneous Agent New Keynesian model," European Economic Review, Elsevier, vol. 145(C).
    11. Spector, Mariano, 2024. "Redistributive fiscal policy and marginal propensities to consume," Journal of Economic Theory, Elsevier, vol. 218(C).
    12. Bilbiie, Florin O., 2020. "The New Keynesian cross," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 90-108.
    13. Stéphane Dupraz, 2023. "The Dynamic IS Curve when there is both Investment and Savings," Working papers 905, Banque de France.
    14. Bilbiie, Florin O. & Känzig, Diego R. & Surico, Paolo, 2022. "Capital and income inequality: An aggregate-demand complementarity," Journal of Monetary Economics, Elsevier, vol. 126(C), pages 154-169.
    15. Rodolfo G. Campos & Jesús Fernández-Villaverde & Galo Nuño & Peter Paz, 2024. "Navigating by Falling Stars: Monetary Policy with Fiscally Driven Natural Rates," NBER Working Papers 32219, National Bureau of Economic Research, Inc.
    16. Oliver Pfäuti & Fabian Seyrich, 2022. "A Behavioral Heterogeneous Agent New Keynesian Model," CRC TR 224 Discussion Paper Series crctr224_2022_334, University of Bonn and University of Mannheim, Germany.
    17. Cantore, Cristiano & Meichtry, Pascal, 2024. "Unwinding quantitative easing: State dependency and household heterogeneity," European Economic Review, Elsevier, vol. 170(C).
    18. Bilbiie, F. O. & Galaasen, S. M. & Gurkaynak, R. S. & Maehlum, M. & Molnar, K, 2025. "Hanksson," Cambridge Working Papers in Economics 2516, Faculty of Economics, University of Cambridge.
    19. Paweł Kopiec, 2023. "Frictional product market, supply chains and the impact of government expenditures on private consumption," Bank i Kredyt, Narodowy Bank Polski, vol. 54(3), pages 285-308.
    20. Florin Bilbiie & Xavier Ragot, 2021. "Optimal Monetary Policy and Liquidity with Heterogeneous Households," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 41, pages 71-95, July.
    21. Sushant Acharya & Keshav Dogra, 2020. "Understanding HANK: Insights From a PRANK," Econometrica, Econometric Society, vol. 88(3), pages 1113-1158, May.
    22. García, Benjamín & Giarda, Mario & Lizama, Carlos & Rojas, Ignacio, 2024. "Transmission mechanisms in HANK: An application to Chile," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 5(3).

    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:2501.17458. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.