Fiscal Policy and Liquidity Traps with Heterogeneous Agents

This paper explores global dynamics in a monetary model with limited asset market participation and the zero lower bound on nominal interest rates. It is shown that a rise in government transfers to ‘non- Ricardian’ consumers financed by debt-based taxes to ‘Ricardian’ consumers is capable of escaping disinflationary paths typically convergent to a liquidity trap. Fiscal policy does not need to be unsustainable at the low inflation steady state to avoid liquidity traps, as argued in the context of the standard single representative agent setup.