Munich Personal RePEc Archive

Fiscal Requirements for Price Stability in Economies with Private Provision of Liquidity and Unemployment

Pedro, Gomis-Porqueras (2016): Fiscal Requirements for Price Stability in Economies with Private Provision of Liquidity and Unemployment.

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Abstract

We study the impact of fiscal policies on inflation, unemployment and interest rate spreads dynamics in an environment where firms provide liquidity. Firms link labor and asset markets by hiring workers and issuing claims to their future profits. Matching frictions in the labor market drastically alters the effect of fiscal policy as the tax base increases with the number of jobs filled. As a result, labor market conditions directly affect the return on private assets and inflation dynamics. Moreover, since frictions in decentralized financial markets exist, public and private assets are also used as collateral. These features in the labor and financial markets drastically change the nature of monetary equilibria. In particular, monetary steady states are generically not unique and endogenous fluctuations are observed. Furthermore, characteristics of the labor market affect the demand for private and public assets, making the interaction between monetary and fiscal policies more intricate. Finally, traditional stabilization policies based on frictionless financial and labor markets are not robust to this frictional environment.

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