DP9563 On Keeping Your Powder Dry: Fiscal Foundations of Financial and Price Stability

Author(s): Maurice Obstfeld
Publication Date: July 2013
Keyword(s): bank resolution, banking crisis, financial crisis, financial stability, Fiscal policy, monetary policy
JEL(s): E44, E58, E63, F62, G15, G28
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9563

Banking systems have rapidly grown to a point where for many countries bank assets amount to multiples of GDP. As a consequence, government’s capacity to provide stability-enhancing fiscal guarantees against systemic crises can no longer be taken for granted. As regulation of dynamic financial markets will inevitably be imperfect, prudent governments need to adjust other facets of macroeconomic policy in order to mitigate financial instability. A precautionary approach to fiscal policy, leading to moderate levels of public debt relative to GDP over the medium term, is essential for the credibility of government promises to support the financial system, as well as the broader economy.