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

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Date: June 2016
Publisher: Elsevier B.V.
Document Type: Article
Length: 183 words

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Abstract :

To link to full-text access for this article, visit this link: Byline: Markus Kirchner, Sweder van Wijnbergen Abstract: Recent developments in the euro area highlighted the interactions between fiscal policy, sovereign debt and financial fragility. We introduce asset choice and sovereign debt holdings in banks' portfolios in an otherwise standard macroeconomic model with financial frictions, to emphasize a new crowding-out mechanism through reduced private access to credit when leverage-constrained banks accumulate sovereign debt. When banks are substantially invested in sovereign debt, the effectiveness of fiscal stimuli is impaired because deficit-financed fiscal expansions through this channel crowd out private demand. This channel also significantly reduces the gains from fiscal policy when interest rates are at the Zero Lower Bound. Author Affiliation: (a) Central Bank of Chile, Chile (b) University of Amsterdam, Roetersstraat 11, 1018 WB Amsterdam, The Netherlands (c) Tinbergen Institute, The Netherlands Article History: Received 2 August 2012; Revised 23 April 2016; Accepted 25 April 2016 Article Note: (footnote) [star] The views expressed in this paper do not necessarily reflect the position of the Central Bank of Chile or its Board members.

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Gale Document Number: GALE|A471828151