A note on optimal fiscal policy in an economy with private borrowing limits

- A model with non-distortionary taxes, heterogeneous households, and borrowing constraints is proposed.
- Tax financing tightens private borrowing constraints whereas public debt financing relaxes them.
- For high public debt, private borrowing constraints are fully relaxed and Ricardian equivalence holds.
- Optimal policy preserves binding borrowing constraints so as to reduce interest rates on public debt.

We consider the implications for optimal fiscal policy when taxes are non-distortionary and households are heterogeneous and borrowing constrained. The main result is that optimal policy keeps some households borrowing constrained in order to reduce interest rates on government debt.