Discussion Paper Details

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Title: Liquidity and Inefficient Investment

Author(s): Oliver Hart and Luigi Zingales

Publication Date: July 2013

Keyword(s): aggregate shocks, fiscal policy, liquidity, nonpledgeability and pecuniary externalities

Programme Area(s): Financial Economics

Abstract: We study the role of fiscal policy in a complete markets model where the only friction is the non-pledgeability of human capital. We show that the competitive equilibrium is constrained inefficient, leading to too little risky investment. We also show that fiscal policy following a large negative shock can increase ex ante welfare. Finally, we show that if the government cannot commit to the promised level of fiscal intervention, the ex post optimal fiscal policy will be too small from an ex ante perspective.

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Bibliographic Reference

Hart, O and Zingales, L. 2013. 'Liquidity and Inefficient Investment'. London, Centre for Economic Policy Research.