Public debt expansions and the dynamics of the household borrowing constraint

We show that the endogeneity of the household borrowing constraint accounts for a sizeable part of the effects in output, credit and welfare of fiscal policies that entail government debt expansions, using an incomplete-markets model featuring heterogeneous agents. These policies make the borrowing constraint tighter because of a higher interest rate. The tightening favors a deleveraging process in terms of private credit and reinforces the precautionary saving motive. This in turn exerts a downward pressure on the interest rate, dampening the tightening itself. As an example, under a plausible debt-financed transfers policy, the majority of households supports the policy within our baseline economy with the endogenous borrowing constraint, whereas it is against the policy if the endogeneity of the borrowing limit is not considered.