Liquidity and Inefficient Investment
38 Pages Posted: 9 Jul 2013
There are 2 versions of this paper
Liquidity and Inefficient Investment
Date Written: July 2013
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.
Keywords: aggregate shocks, fiscal policy, liquidity, nonpledgeability, pecuniary externalities
JEL Classification: E41, E51, G21
Suggested Citation: Suggested Citation