We study the effect of expansionary fiscal policies (transfers to households or purchases of goods and services from the private sector) on the household borrowing constraint, and how the shift in such a constraint influences reactions to the policies. We use a macroeconomic model with flexible prices, calibrated for the United States, within which households, that differ by wealth and productivity, are constrained by the maximum quantity they can borrow.
Expansionary fiscal policies tighten the borrowing limit because of a higher interest rate due to the issuance of public debt. The constrained households must deleverage while the richer ones, though farther from the constraint, increase their level of precautionary saving. This depresses both credit and consumption but stimulates labor supply, which in turn amplifies the output multiplier.
Published in 2020 in: Review of Economic Dynamics, v. 37, pp. 1-32
