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Monetary–fiscal interactions with endogenous liquidity frictions

Cui, W; (2016) Monetary–fiscal interactions with endogenous liquidity frictions. European Economic Review , 87 pp. 1-25. 10.1016/j.euroecorev.2016.03.007. Green open access

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Abstract

I develop a tractable macro model with endogenous asset liquidity to understand monetary–fiscal interactions with liquidity frictions. Agents face idiosyncratic investment risks and meet financial intermediaries in competitive search markets. Asset liquidity is determined by the search friction and the cost of operating the financial intermediaries, and it drives the financing constraints of entrepreneurs (those who have investment projects) and their ability to invest. In contrast to private assets, government bonds are fully liquid and can be accumulated in anticipation of future opportunities to invest. A higher level of real government debt enhances the liquidity of entrepreneurs׳ portfolios and raises investment. However, the issuance of debt also raises the cost of financing government expenditures: a higher level of distortionary taxation and/or a higher real interest rate. A long-run optimal supply of government debt emerges. I also show that a proper mix of monetary and fiscal policies can avoid a deep financial recession.

Type: Article
Title: Monetary–fiscal interactions with endogenous liquidity frictions
Open access status: An open access version is available from UCL Discovery
DOI: 10.1016/j.euroecorev.2016.03.007
Publisher version: http://dx.doi.org/10.1016/j.euroecorev.2016.03.007
Language: English
Additional information: Copyright © 2016 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/)
Keywords: Liquidity frictions; Monetary and fiscal interactions
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/1492860
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