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Monetary–fiscal interactions with endogenous liquidity frictions

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  • Cui, Wei

Abstract

I develop a tractable macro model with endogenous asset liquidity to understand monetary–fiscal interactions with liquidity frictions. Agents face idiosyncratic investment risks and meet financial intermediaries in competitive search markets. Asset liquidity is determined by the search friction and the cost of operating the financial intermediaries, and it drives the financing constraints of entrepreneurs (those who have investment projects) and their ability to invest. In contrast to private assets, government bonds are fully liquid and can be accumulated in anticipation of future opportunities to invest. A higher level of real government debt enhances the liquidity of entrepreneurs׳ portfolios and raises investment. However, the issuance of debt also raises the cost of financing government expenditures: a higher level of distortionary taxation and/or a higher real interest rate. A long-run optimal supply of government debt emerges. I also show that a proper mix of monetary and fiscal policies can avoid a deep financial recession.

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  • Cui, Wei, 2016. "Monetary–fiscal interactions with endogenous liquidity frictions," European Economic Review, Elsevier, vol. 87(C), pages 1-25.
    • Handle: RePEc:eee:eecrev:v:87:y:2016:i:c:p:1-25
    DOI: 10.1016/j.euroecorev.2016.03.007
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    Cited by:

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    2. Andolfatto, David & Martin, Fernando M., 2018. "Monetary policy and liquid government debt," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 183-199.
    3. Li, Bing & Pei, Pei & Tan, Fei, 2021. "Financial distress and fiscal inflation," Journal of Macroeconomics, Elsevier, vol. 70(C).
    4. Wei Cui & Vincent Sterk, 2018. "Quantitative Easing," Discussion Papers 1830, Centre for Macroeconomics (CFM).
    5. Saroj Dhital & Pedro Gomis-Porqueras & Joseph H. Haslag, 2020. "Monetary and Fiscal Policy Interactions in a Frictional Model of Money, Nominal Public Debt and Banking," Working Papers 2002, Department of Economics, University of Missouri.
    6. Begona Dominguez & Pedro Gomis-Porqueras, 2019. "The effects of secondary markets for government bonds on inflation dynamics," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 249-273, April.
    7. Asimakopoulos, Panagiotis & Asimakopoulos, Stylianos, 2019. "Fiscal policy with banks and financial frictions," Journal of Financial Stability, Elsevier, vol. 40(C), pages 94-109.
    8. Marco Bassetto & Wei Cui, 2024. "A Ramsey Theory of Financial Distortions," Journal of Political Economy, University of Chicago Press, vol. 132(8), pages 2612-2654.
    9. Marco Bassetto & Wei Cui, 2018. "The Fiscal Theory of the Price Level in an Environment of Low Interest Rates," 2018 Meeting Papers 574, Society for Economic Dynamics.
    10. Eugene Msizi BUTHELEZI, 2023. "Examining the Dynamic Nexus of Monetary and Fiscal Policy in South Africa: Evidence from Key Macroeconomic Economic Indicators," Journal of Economics and Financial Analysis, Tripal Publishing House, vol. 7(1), pages 13-42.
    11. Bayer, Christian & Born, Benjamin & Luetticke, Ralph, 2023. "The liquidity channel of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 134(C), pages 86-117.
    12. Bassetto, Marco & Cui, Wei, 2018. "The fiscal theory of the price level in a world of low interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 5-22.
    13. Cui, Wei & Sterk, Vincent, 2021. "Quantitative easing with heterogeneous agents," Journal of Monetary Economics, Elsevier, vol. 123(C), pages 68-90.
    14. Gomes, Pedro & Seoane, Hernán D., 2024. "Made in Europe: Monetary–Fiscal policy mix with financial frictions," European Economic Review, Elsevier, vol. 165(C).
    15. Chen, Peng & Miao, Xinru, 2024. "Understanding the role of China's factors in international commodity price fluctuations: A perspective of monetary-fiscal policy interaction," Economic Analysis and Policy, Elsevier, vol. 81(C), pages 1464-1483.
    16. Kim, Jeong-Yoo & Choi, Hyung Sun, 2023. "Monetary policy, fiscal policy and cross signal jamming," Journal of Macroeconomics, Elsevier, vol. 75(C).
    17. He, Ping & Liu, Zehao & Xie, Chengbo, 2023. "A fiscal theory of money and bank liquidity provision," Journal of Economic Theory, Elsevier, vol. 214(C).
    18. Wang, Ling, 2018. "Monetary-fiscal policy interactions under asset purchase programs: Some comparative evidence," Economic Modelling, Elsevier, vol. 73(C), pages 208-221.
    19. Xi Wang & Jiayang Li & Guangbin Zhang, 2022. "Mixed Monetary–Fiscal Policies and Macroeconomic Fluctuations: An Analysis Based on the Dynamic Stochastic General Equilibrium Model," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 30(2), pages 167-196, March.

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    More about this item

    Keywords

    Liquidity frictions; Monetary and fiscal interactions;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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