Analysis of macro‐prudential and ex post financial crisis interventions: Relevance of the fiscal‐policy setup

Carmina Vargas and Julian A. Parra‐Polania
Authors registered in the RePEc Author Service: Julián Andrés Parra-Polanía

International Journal of Finance & Economics, 2021, vol. 26, issue 3, 3759-3769

Abstract: In the analysis of financial crises from the pecuniary externality perspective, it is common to assume that (a) lenders overlook the effect of lump‐sum taxes/subsidies on borrowers' debt repayment capacity and (b) there is a balanced‐budget fiscal policy. By modifying the first assumption (i.e., the financial constraint) we find a significant result for the debate on ex‐ante vs. ex post crisis interventions: the latter could be completely ineffective to manage crises and, instead, macro‐prudential policies are still able to correct the externality that stems from the underestimation of the social costs of decentralized debt decisions. By modifying both assumptions (i.e., with the modified financial constraint and counter‐cyclical fiscal policy) we find that some combinations of policy interventions could completely avoid crises, but under restrictive conditions.

Date: 2021
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