The return of expansionary austerity: Firms' investment response to fiscal adjustments in emerging markets

Nicolas Magud and Samuel Pienknagura

Journal of International Money and Finance, 2024, vol. 143, issue C

Abstract: In emerging markets, unexpected public expenditure reductions increase firm-level investment, which quickly surpasses pre-shock levels after a temporary contraction, owing to a decline in financing costs. Consistent with the role played by financing cost dynamics and financial frictions, we show that countries with lower sovereign credit ratings (those that are not investment grade) experience a sharper boost in investment. In addition, we find that investment's recovery is facilitated by trade openness, public spending predictability, and exchange rate flexibility. In fact, exchange rate flexibility facilitates the real depreciation that result from the fiscal adjustment, which decreases (relative) domestic demand for non-tradable (akin to Diaz-Alejandro, 1966) and increases external demand for tradables, boosting investment. We show that adjustment composition matters: reductions in public consumption (vis-à-vis public investment) yield larger private investment contractions on impact but result in quicker and more sustainable recoveries. Exploiting firm-level heterogeneity we show that investment's expansion is stronger in the tradable-sector, in larger, and in less indebted firms. We provide evidence that the medium-term benefits of fiscal shocks to firm-level activity outweigh their short-run costs.

Keywords: Fiscal shocks; Adjustment; Corporate investment; Emerging markets (search for similar items in EconPapers)
JEL-codes: D22 E22 E62 F40 H32 H50 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0261560624000597
Full text for ScienceDirect subscribers only

Related works:
Working Paper: The Return of Expansionary Austerity: Firms’ Investment Response to Fiscal Adjustments in Emerging Markets (2022)
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:eee:jimfin:v:143:y:2024:i:c:s0261560624000597

DOI: 10.1016/j.jimonfin.2024.103072

Access Statistics for this article

Journal of International Money and Finance is currently edited by J. R. Lothian

More articles in Journal of International Money and Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().