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

Julio Carrillo and Céline Poilly ()

Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

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 ?rms?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- de?ation channel.

Keywords: Financial Frictions; Zero Lower Bound; Fiscal Policy (search for similar items in EconPapers)
JEL-codes: E52 E62 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2012-03
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: How do financial frictions affect the spending multiplier during a liquidity trap? (2013)
Working Paper: Online Appendix to "How do financial frictions affect the spending multiplier during a liquidity trap?" (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:rug:rugwps:12/779

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