Public debt, iMPCs & fiscal policy transmission

In this paper, I examine the relationship between public debt and the effectiveness of fiscal policy, presenting evidence of an inverse relationship between government debt and fiscal multipliers. To explain the results, I develop and calibrate a HANK model tailored to the U.S. economy. The model reveals that higher public debt diminishes fiscal multipliers by making households less constrained; with more debt serving as a liquidity self-insurance tool, agents exhibit a weaker labor response to fiscal shocks. Theoretically, I show intertemporal marginal propensities to consume (iMPCs) are a sufficient statistic of public debt and consequently this influences fiscal multipliers. I then decompose the changes in iMPCs to those that come out of wealth distribution and policy function and I find that the primary factor driving variations in iMPCs is the change in interest rates due to the variation of government bonds. Although redistribution across households remains central to the transmission of fiscal policy, this paper is the first to show that other channels also influence discretionary fiscal policy’s overall impact, especially in economies with higher debt.