DP12394 Financial Fragility and the Keynesian Multiplier
|Author(s):||Christiaan van der Kwaak, Sweder van Wijnbergen|
|Publication Date:||October 2017|
|Keyword(s):||Financial Intermediation; Macrofinancial Fragility; Fiscal Policy; Sovereign Default Risk|
|JEL(s):||E44, E62, H30|
|Programme Areas:||International Macroeconomics and Finance|
|Link to this Page:||www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12394|
Abstract We investigate the effectiveness of fiscal stimuli when banks are undercapitalized and have large holdings of government bonds subject to sovereign default risk. Deficit-financed government purchases then crowd out private expenditure and fiscal multipliers can turn negative. Crowding out increases for longer maturity bonds and higher sovereign default risk. We estimate a DSGE model with financial frictions for Spain and find that investment crowding out indeed leads to a negative cumulative fiscal multiplier. When monetary policy is exogenous, like at the ZLB or in a currency union, fiscal stimuli become more effective but multipliers are reduced when banks are undercapitalized.