Discussion paper

DP14883 The Liquidity Channel of Fiscal Policy

We provide evidence that expansionary fiscal policy lowers the return difference between public debt and less liquid assets---the liquidity premium. We rationalize this finding in an estimated heterogeneous-agent New-Keynesian model with incomplete markets and portfolio choice, in which public debt affects private liquidity. This liquidity channel stabilizes fixed-capital investment. We then quantify the long-run effects of higher public debt and find little crowding out of capital, but a sizable decline of the liquidity premium, which increases the fiscal burden of debt. We show that the revenue-maximizing level of public debt is positive and has increased to 60 percent of US GDP post-2010.


Bayer, C, B Born and R Luetticke (eds) (2020), “DP14883 The Liquidity Channel of Fiscal Policy”, CEPR Press Discussion Paper No. 14883. https://cepr.org/publications/dp14883-2