How do financial frictions affect the spending multiplier during a liquidity trap?

Julio Carrillo and Céline Poilly ()

Review of Economic Dynamics, 2013, vol. 16, issue 2, 296-311

Abstract: We show that credit market imperfections substantially increase the government-spending multiplier when the economy enters a liquidity trap. This finding is explained by the tight association between capital goods and firms' collateral, a relationship that we highlight as the capital-accumulation channel. During a liquidity trap, a government spending expansion reduces the real interest rate, leading to a period of cheap credit. Entrepreneurs use this time to accumulate capital, which persistently improves their balance sheets and reduces their future costs of credit. A public spending expansion can thus encourage private investment, yielding consequently a large spending multiplier. This effect is further reinforced by Fisher's debt-deflation channel. (Copyright: Elsevier)

Keywords: Financial frictions; Zero lower bound; Fiscal policy (search for similar items in EconPapers)
JEL-codes: E52 E62 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (62)

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Working Paper: Online Appendix to "How do financial frictions affect the spending multiplier during a liquidity trap?" (2013)
Working Paper: How do financial frictions affect the spending multiplier during a liquidity trap? (2012)
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DOI: 10.1010/j.red.2013.01.004

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