Working Paper: CEPR ID: DP14883
Authors: Christian Bayer; Benjamin Born; Ralph Luetticke
Abstract: We provide evidence that expansionary fiscal policy lowers the return difference between public debt and less liquid assets---the liquidity premium. We rationalize this finding in an estimated heterogeneous-agent New-Keynesian model with incomplete markets and portfolio choice, in which public debt affects private liquidity. This liquidity channel stabilizes fixed-capital investment. We then quantify the long-run effects of higher public debt and find little crowding out of capital, but a sizable decline of the liquidity premium, which increases the fiscal burden of debt. We show that the revenue-maximizing level of public debt is positive and has increased to 60 percent of US GDP post-2010.
Keywords: Business Cycles; Fiscal Policy; HANK; Impulse Response Matching; Incomplete Markets; Liquidity Premium; Public Debt
JEL Codes: C11; D31; E21; E32; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expansionary fiscal policy (E62) | decrease in liquidity premium (E41) |
| increase in public debt (H69) | greater liquidity to the economy (E44) |
| increase in public debt (H69) | stabilization of fixed-capital investment (E22) |
| increase in public debt (H69) | less crowding out of capital (E22) |
| expansionary fiscal policy shock (E62) | decrease in liquidity premium (E41) |
| revenue-maximizing level of public debt (H63) | approximately 60% of US GDP (E20) |