The Liquidity Channel of Fiscal Policy

We provide evidence that expansionary fiscal policy lowers the return difference between more and less liquid assets—the liquidity premium. We rationalize this finding in an estimated heterogeneous-agent New-Keynesian (HANK) model with incomplete markets and portfolio choice, in which public debt affects private liquidity. In this environment, the short-run fiscal multiplier is amplified by the countercyclical liquidity premium. This liquidity channel stabilizes investment and crowds in consumption. We then quantify the long-run effects of higher public debt, and find a sizable decline of the liquidity premium, increasing the fiscal burden of debt, but little crowding out of capital

Transmission of monetary policy with heterogeneity in household portfolios

Monetary policy affects both intertemporal consumption choices and portfolio choices between liquid and illiquid assets. The monetary transmission, in turn, depends on the distribution of marginal propensities to consume and invest. This paper assesses the importance of heterogeneity in these propensities for the transmission of monetary policy in a New Keynesian business cycle model with uninsurable income risk and assets with different degrees of liquidity. Liquidity-constrained households have high propensities to consume but low propensities to invest, which makes consumption more and investment less responsive to monetary shocks compared to complete markets. Redistribution through earnings heterogeneity and the Fisher channel from unexpected inflation further amplifies the consumption response but dampens the investment response