Public spending, currency mismatch and financial frictions

Hory Marie Pierre,, Grégory Levieuge and Onori Daria.

Working papers from Banque de France

Abstract: In this paper, we demonstrate that the size of the fiscal multiplier depends both on currency mismatch and home bias. Our demonstration is based on a real two-country dynamic stochastic general equilibrium model with incomplete and imperfect international financial markets, external debt and financial frictions. We show that if home bias is high, the terms of trade improve following a fiscal stimulus. This reduces the private real debt burden denominated in foreign currency, decreases the external finance premium born by firms, and stimulates investment. Thus, the larger the proportion of firms' debt denominated in foreign currency is, the higher the fiscal multiplier. In contrast, the terms of trade deteriorate when home bias is low. This increases the real debt burden and the external finance premium. Hence, in this case, the fiscal multiplier decreases as the share of firms' debt denominated in foreign currency increases.

Keywords: Fiscal Multiplier; Terms of Trade; Currency Mismatch; DSGE Model; Financial Frictions. (search for similar items in EconPapers)
JEL-codes: E62 F34 F41 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2021
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-isf, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Public spending, currency mismatch and financial frictions (2021)
Working Paper: Public spending, currency mismatch and financial frictions (2021)
Working Paper: Public spending, currency mismatch and financial frictions (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:813

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