Type
Working paper
Title
Public spending shock in a liquidity constrained economy
In
Working Paper PSE
Author(s)
CHALLE Edouard - (Author)
RAGOT Xavier - Département d'économie (Author)
Editor
Paris-Jourdan Sciences Economiques
Collection
Working Paper PSE : 2007-48
Keywords
Borrowing constraints, Public debt, Fiscal policy shocks
Abstract
EN
This paper analyses the e§ects of transitory increases in government spending when public debt is used as liquidity by the private sector. Aggregate shocks are introduced into a áexible-price, incomplete-market economy where heterogenous, inÖnitely-lived households face occasionally binding borrowing constraints and store wealth to smooth out idiosyncratic income áuctuations. Debt-Önanced 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 Örms, 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 e§ects that arise following the shock.

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