Financial frictions and stabilization policies

Beatriz de Blas () and María Malmierca

Economic Modelling, 2020, vol. 89, issue C, 166-188

Abstract: After the financial crisis of 2007, in many economies, public and private debt have moved in opposite directions, as opposed to pre-2007 evidence. Private deleverage and public debt build-up may affect the recovery path of countries after a recession. In a new Keynesian model with financial frictions, we show that when the economy is hit by a credit risk shock, the negative correlation arising between public and private debt amplifies the response of GDP. In our setup, the traditional monetary-fiscal policy mix is not enough to offset this private-public debt mechanism and therefore bring back economic stability. When macroprudential policy is part of the policy mix, the private-public debt channel can be broken. Interestingly, depending on the macroprudential instrument, a trade-off may arise between private debt and output stabilization.

Keywords: Financial accelerator; Macroprudential policy; Fiscal and monetary policy mix; Public and private debt (search for similar items in EconPapers)
JEL-codes: E52 E62 E63 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:89:y:2020:i:c:p:166-188

DOI: 10.1016/j.econmod.2019.10.019

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