DP9088 Public Debt and Redistribution with Borrowing Constraints

Author(s): Florin Ovidiu Bilbiie, Tommaso Monacelli, Roberto Perotti
Publication Date: August 2012
Keyword(s): borrowing constraint, public debt, redistribution, tax cuts
JEL(s): E44, E62
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9088

In an economy with financial imperfections, Ricardian equivalence holds when prices are flexible and the steady-state distribution of consumption is uniform, or labor is inelastic. With different steady-state consumption levels, Ricardian equivalence fails, but tax cuts, somewhat paradoxically, are contractionary; the present-value multiplier on consumption is, however, zero. With sticky prices, Ricardian equivalence always fails. A Robin-Hood, revenue-neutral redistribution to borrowers is expansionary on aggregate activity. A uniform cut in taxes financed with public debt has a positive present-value multiplier on consumption, stemming from intertemporal substitution by the savers, who hold the public debt.