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435. Public Debt and Redistribution with Borrowing Constraints.
by Florin Bilbiie, Tommaso Monacelli, Roberto Perotti

The effects of public debt and redistribution are intimately related. We illustrate this in a model with heterogenous agents and imperfect credit markets. Our setup differs from the classic Savers-Spenders model of fiscal policy in that all agents engage in intertemporal optimization, but a fraction of them is subject to a borrowing limit. We show that, despite the credit frictions, Ricardian equivalence holds under flexible prices if the steady-state distribution of wealth is degenerate: income effects on labor supply deriving from a tax redistribution are entirely symmetric across agents. When the distribution of wealth is non-degenerate, a tax cut is, somewhat paradoxically, contractionary. Conversely, sticky prices generate empirically plausible deviations from Ricardian equivalence, even in the case of degenerate wealth distribution. A revenue-neutral redistribution from unconstrained to constrained agents is expansionary, while debt…nanced tax cuts have effects that go beyond their redistributional component: the present-value multiplier of a tax cut is positive due to an interplay of intertemporal substitution by those who hold the public debt and income effects on those who do not.

Last updated May 3, 2012