Working Paper: NBER ID: w18800
Authors: Georgemarios Angeletos; Fabrice Collard; Harris Dellas; Behzad Diba
Abstract: We study the Ramsey policy problem in an economy in which firms face a collateral constraint. Issuing more public debt alleviates this friction by increasing the aggregate quantity of collateral. In so doing, however, the issuance of more debt also raises interest rates, which in turn increases the tax burden of servicing the entire outstanding debt. We first document how this trade-off upsets the optimality of tax smoothing and, in contrast to the standard paradigm, helps induce a unique and stable steady-state level of debt in the deterministic version of the model. We next study the optimal policy response to fiscal and financial shocks in the stochastic version. We finally show how the results extend to a variant model in which the financial friction afflicts consumers rather than firms.
Keywords: public debt; liquidity provision; collateral constraints; fiscal policy
JEL Codes: E4; E6; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Public debt issuance (H63) | Alleviation of financial frictions (G59) |
| Alleviation of financial frictions (G59) | Increase in aggregate quantity of collateral available (E51) |
| Increase in aggregate quantity of collateral available (E51) | Improved liquidity for private agents (G19) |
| Increased public debt (H69) | Lower interest rates (E43) |
| Increased public debt (H69) | Higher tax burden (H22) |
| Higher tax burden (H22) | Servicing the debt (H63) |
| Initial level of public debt is high (H69) | Optimal to gradually reduce level of debt (H63) |
| Initial level of public debt is low (H63) | Issue more debt to relax financial frictions (H63) |
| Increase in government spending (H59) | Front-loaded tax increase (H22) |
| Front-loaded tax increase (H22) | Manage liquidity and reduce future tax burdens (G33) |