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The road to recovery: Fiscal stimulus, financial sector rehabilitation, and potential risks ahead

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  • Zhang, Zhiwei
  • Zhang, Wenlang
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    Abstract

    The worst of the global financial crisis is behind us, but the trajectory to recovery varies widely across economies. Employing a dynamic structural multi-country model with a financial accelerator, this paper studies the roles of two important policy actions in economic recovery: fiscal stimulus and financial sector rehabilitation. The main finding is that while both factors contribute to economic recovery, the former is likely to be less effective from a medium-term perspective and may generate some negative side effects. This suggests that policy priority should be on continued financial sector rehabilitation, particularly in advanced economies. Moreover, international policy co-ordination is beneficial as it can generate spill-over effects to regional economies. We also study a potential risk to economic recovery down the road: an over-estimation of the post-crisis potential output by the monetary authorities in advanced economies. It is found that this may lead to an overly accommodative monetary policy stance, which could lead to a resurgence in inflation and hence will darken the medium-term growth prospects of the world economy.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1049007811000236
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Asian Economics.

    Volume (Year): 22 (2011)
    Issue (Month): 4 (August)
    Pages: 311-321

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    Handle: RePEc:eee:asieco:v:22:y:2011:i:4:p:311-321

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    Web page: http://www.elsevier.com/locate/asieco

    Related research

    Keywords: GIMF model Financial accelerator Fiscal stimulus Financial rehabilitation;

    References

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    1. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
    2. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
    3. Dong He & Zhiwei Zhang & Wenlang, 2009. "How Large Will Be the Effect of China's Fiscal-Stimulus Package on Output and Employment?," Working Papers 0905, Hong Kong Monetary Authority.
    4. Lillian Cheung & Chi-Sang Tam & Jessica Szeto, 2009. "Deteriorating Public Finances and Rising Government Debt: Implications for Monetary Policy," Working Papers 0915, Hong Kong Monetary Authority.
    5. Mishkin, Frederic S., 2010. "Monetary policy flexibility, risk management, and financial disruptions," Journal of Asian Economics, Elsevier, vol. 21(3), pages 242-246, June.
    6. Simon G. Gilchrist & Ben Bernanke & Mark Gertler, 1994. "The financial accelerator and the flight to quality," Finance and Economics Discussion Series 94-18, Board of Governors of the Federal Reserve System (U.S.).
    7. Douglas Laxton & Michael Kumhof, 2007. "A Party without a Hangover? On the Effects of U.S. Government Deficits," IMF Working Papers 07/202, International Monetary Fund.
    8. Douglas Laxton & Susanna Mursula & Michael Kumhof & Dirk Muir, 2010. "The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure," IMF Working Papers 10/34, International Monetary Fund.
    9. Sanjeev Gupta & Carlos Mulas-Granados & Emanuele Baldacci, 2009. "How Effective is Fiscal Policy Response in Systemic Banking Crises?," IMF Working Papers 09/160, International Monetary Fund.
    10. Davide Furceri & Annabelle Mourougane, 2009. "The Effect of Financial Crises on Potential Output: New Empirical Evidence from OECD Countries," OECD Economics Department Working Papers 699, OECD Publishing.
    11. Jahyeong Koo & Sherry L. Kiser, 2001. "Recovery from a financial crisis: the case of South Korea," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q IV, pages 24-36.
    12. Zhang, Wenlang & Zhang, Zhiwei & Han, Gaofeng, 2010. "How does the US credit crisis affect the Asia-Pacific economies?--Analysis based on a general equilibrium model," Journal of Asian Economics, Elsevier, vol. 21(3), pages 280-292, June.
    13. Axel Schimmelpfennig & Selma Mahfouz & Richard Hemming, 2002. "Fiscal Policy and Economic Activity During Recessions in Advanced Economies," IMF Working Papers 02/87, International Monetary Fund.
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