Fiscal Policy with Heterogeneous Agents, Banks and Financial Frictions

Abstract

We assess the role of banks to the transmission of fiscal policy reforms to the economy. We built-up a dynamic stochastic general equilibrium model with heterogeneous agents, banks and government. We find that banks mitigate the negative spillover effects to the economy from higher taxes. Specifically, housing taxes exhibit negative effects to the economy in the short-run and positive in the long-run, if they are welfare enhancing. Borrowers are affected the most from higher housing taxes. The existence of banks benefits impatient households from higher consumption taxes, whereas higher housing tax, targeted on patient households and entrepreneurs, decreases agents' welfare.

Keywords: fiscal policy, heterogeneous agents, financial frictions

JEL Classification: E21, E44, E47, E62, H24