Financial Fragility and the Keynesian Multiplier

Sweder van Wijnbergen and Christiaan van der Kwaak

No 12394, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: 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.

Keywords: Macrofinancial fragility; Sovereign default risk; Financial intermediation; Fiscal policy (search for similar items in EconPapers)
JEL-codes: E44 E62 H30 (search for similar items in EconPapers)
Date: 2017-10
New Economics Papers: this item is included in nep-dge, nep-eec, nep-mac, nep-pbe and nep-pke
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