Fiscal policy and asset purchases in a liquidity constrained economy

Prasad, Vivek (2015) Fiscal policy and asset purchases in a liquidity constrained economy. PhD thesis, Birkbeck, University of London.

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This thesis modifies the basic neoclassical DSGE model of Kiyotaki and Moore (2012) by introducing a government which levies distortionary taxes on wages and dividends, consumes general output, issues money, and holds privately-issued equity. The thesis answers two questions - Can discretionary policy relieve the effects of liquidity constraints that limit investment, and thereby stimulate economic activity in normal times? Can discretionary policy ameliorate the effects of an exogenous liquidity shock? Including distortionary taxes is a unique modification within a branch of literature that extends the work of KM and studies liquidity shocks. The thesis belongs to a branch of this literature which modifies KM's basic model, but none of these papers have distortionary taxes and none examine fiscal policy. The thesis extends the literature with a novel variant of the basic KM model and with a novel set of policies against a liquidity shock. The results are as follows. Firstly, if money supply is constant and government spending varies to always balance the fiscal budget, then across-the-board tax cuts persistently stimulate the economy and a cut in the rate of tax on dividends ameliorates a liquidity shock without additional distortions. These responses are robust to the model's calibration. Secondly, an increase in government spending, financed by more taxes or selling equity holdings, persistently worsens economic activity and exacerbates a liquidity shock; financing the policies is what brings adverse results. Thirdly, the direct effects of a government equity purchase programme are short-lived - investment rises and new equity is added to the market which partially offsets the government's purchase. Financing the programme with spending cuts do less harm than raising taxes. Adding monetary expansion to the policy mix improves aggregate supply but reduces aggregate demand. When used against a liquidity shock, the programme makes a positive but short-lived difference.

Item Type: Thesis (PhD)
Additional Information: Date of PhD award confirmed as 2015 by registry
Copyright Holders: The copyright of this thesis rests with the author, who asserts his/her right to be known as such according to the Copyright Designs and Patents Act 1988. No dealing with the thesis contrary to the copyright or moral rights of the author is permitted.
School/Department: School of Business, Economics & Informatics > Economics, Mathematics & Statistics
Depositing User: ORBIT Editor
Date Deposited: 29 Jan 2015 11:00
Last Modified: 02 Dec 2016 12:47

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