Economics at your fingertips  

State of confidence, overborrowing and the macroeconomic stabilization puzzle: a system dynamic approach

Eleonora Cavallaro () and Bernardo Maggi

No 174, Working Papers from University of Rome La Sapienza, Department of Public Economics

Abstract: We model macroeconomic instability as the outcome of the dynamic interaction between debt accumulation and the “state of confidence†in a small open economy with a super-fixed exchange-rate arrangement. We use a system dynamic approach and show that instability is a likely feature when macroeconomic behaviour is characterized by out-of-equilibrium dynamics with balance-sheet effects and deviation amplifying expectation formation rules that interact endogenously. We address the issue of the macroeconomic stabilization puzzle and carry out a quantitative evaluation based on sensitivity analysis with reference to Argentina, during the currency-board arrangement. We find that a tight fiscal policy is likely to be destabilizing inasmuch as it adds to the fall in expenditure, output and the “state of confidence†. On the other side, a traditional monetary policy can fail in switching off macroeconomic instability if the reduction in interest rates does not compensate for the fall in the “state of confidence†, whilst a direct stimulus to aggregate expenditure is required to avoid an economic collapse.

Keywords: macrodynamic financial fragility; (in-)stability; stabilization policies; sensitivity and continuous-time quantitative analysis (search for similar items in EconPapers)
JEL-codes: F34 F31 E63 C61 (search for similar items in EconPapers)
Pages: 35
Date: 2016-07
New Economics Papers: this item is included in nep-mac and nep-sog
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1) Track citations by RSS feed

Downloads: (external link) (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this paper

More papers in Working Papers from University of Rome La Sapienza, Department of Public Economics Contact information at EDIRC.
Bibliographic data for series maintained by Luisa Giuriato ().

Page updated 2020-03-31
Handle: RePEc:sap:wpaper:wp174