Fiscal deficits, financial fragility, and the effectiveness of government policies

Markus Kirchner and Sweder van Wijnbergen

No 20/2012, Discussion Papers from Deutsche Bundesbank

Abstract: Recent macro developments in the euro area have highlighted the interactions between fiscal policy, sovereign debt, and financial fragility. We take a structural macroeconomic model with frictions in the financial intermediation process, in line with recent research, but introduce asset choice and sovereign debt holdings in the portfolio of banks. Using this model, we emphasize a new crowding-out mechanism that works through reduced private access to credit when banks accumulate sovereign debt under a leverage constraint. Our results show that, when banks invest a substantial fraction of their assets in sovereign debt, the effectiveness of fiscal stimulus policies may be impaired because deficit-financed fiscal expansions may tighten financial conditions to such an extent that private demand is crowded out. We also analyze the macroeconomic effectiveness of liquidity support to commercial banks through recapitalizations or loans by the government and the impact of different ways of financing those policies.

Keywords: financial intermediation; fiscal policy; sovereign debt (search for similar items in EconPapers)
JEL-codes: E44 E62 H30 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-ban, nep-eec and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Downloads: (external link)
https://www.econstor.eu/bitstream/10419/64819/1/726784702.pdf (application/pdf)

Related works:
Journal Article: Fiscal deficits, financial fragility, and the effectiveness of government policies (2016)
Working Paper: Fiscal Deficits, Financial Fragility, and the Effectiveness of Government Policies (2012)
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: https://EconPapers.repec.org/RePEc:zbw:bubdps:202012

Access Statistics for this paper

More papers in Discussion Papers from Deutsche Bundesbank Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics ().