Debt-financed fiscal policies and the dynamics of the household borrowing constraint

We study the eects of temporary government debt expansions, used to nance plausible increases in transfers or in purchases, on the household borrowing constraint and how changes in the latter in uence the households' reactions to the policies. We perform the analysis within an incomplete-markets model featuring consumer credit and endogenous borrowing constraints. We show that issuing public debt produces a persistent tightening in the household borrowing constraint, via an increase in the interest rate or in the borrowing costs. Because of the tightening, debt-constrained agents deleverage, thus working (consuming) more (less). Unconstrained agents do the same for precautionary saving reasons. In the aggregate, both consumer credit and physical capital are crowded out. The dynamics of the borrowing limit explains a signicant share of the aggregate reactions. For example, ten years after the beginning of the debt expansions, the tightening attenuates the fall in physical capital by almost 50% while it reinforces the fall in consumer credit by roughly 25%. The tightening explains around 50% of the ten-year cumulative government spending multipliers.

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