Financial Fragility and the Fiscal Multiplier

Sweder van Wijnbergen and Christiaan van der Kwaak

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We investigate the effectiveness of fiscal stimuli when banks are undercapitalized and have large holdings of government bonds subject to sovereign default risk. Deficit-financed government purchases then crowd out private expenditure and fiscal multipliers can turn negative. Crowding out increases for longer maturity bonds and higher sovereign default risk. We estimate a DSGE model with financial frictions for Spain and find that investment crowding out indeed leads to a negative cumulative fiscal multiplier. When monetary policy is exogenous, like at the ZLB or in a currency union, fiscal stimuli become more effective but multipliers are reduced when banks are undercapitalized.

Keywords: Financial Intermediation; Macrofinancial Fragility; Fiscal Policy; Sovereign Default Risk (search for similar items in EconPapers)
JEL-codes: E44 E62 H30 (search for similar items in EconPapers)
Date: 2014-01-14, Revised 2017-09-19
New Economics Papers: this item is included in nep-cba, nep-mac and nep-pbe
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20140004

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