Fiscal Multipliers with Sovereign Risk and Fragile Banks

Matthieu Darracq Paries, Georg Muller () and Niki Papadopoulou
Additional contact information
Georg Muller: European Central Bank

No 2022-5, Working Papers from Central Bank of Cyprus

Abstract: We quantify the size of fiscal multipliers in an economy with sovereign and bank default risk. We build a DSGE model with financial frictions for the euro area in which the interplay of corporate, bank and sovereign solvency risk a?ects the transmission of government spending. Sovereign bonds carry a credit risk premium that depends on government indebtedness. The banking system is fragile through its direct and indirect exposure to sovereign risk and limited loss absorption capacity. Calibrating the model on sovereign and bank riskiness reminiscent of the euro area sovereign debt crisis period, we show that adverse financial channels may signifcantly depress the fiscal multiplier. The trade-o? for the fiscal authority, between the macroeconomic stabilization objective and solvency risks, continues to be relevant in the euro area. We also evaluate the scope for monetary and macro-prudential policy to mitigate the financial setbacks and help restore the e?ectiveness of fiscal stimulus.

Keywords: DSGE models; fiscal stabilization; sovereign risk; sovereign-bank nexus (search for similar items in EconPapers)
JEL-codes: E44 E52 E62 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2022-12
New Economics Papers: this item is included in nep-ban, nep-dge, nep-eec and nep-fdg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.centralbank.cy/images/media/pdf/Fiscal ... nd-Fragile-Banks.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cyb:wpaper:2022-5

Access Statistics for this paper

More papers in Working Papers from Central Bank of Cyprus Contact information at EDIRC.
Bibliographic data for series maintained by Anna Markidou ().