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How do financial frictions affect the spending multiplier during a liquidity trap?

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Author Info

  • Julio Carrillo

    (University of Ghent)

  • Celine Poilly

    (University of Lausanne)

Abstract

We show that credit market imperfections substantially increase the government-spending multiplier when the economy enters a liquidity trap. This finding is explained by the tight association between capital goods and firms' collateral, a relationship that we highlight as the capital-accumulation channel. During a liquidity trap, a government spending expansion reduces the real interest rate, leading to a period of cheap credit. Entrepreneurs use this time to accumulate capital, which persistently improves their balance sheets and reduces their future costs of credit. A public spending expansion can thus encourage private investment, yielding consequently a large spending multiplier. This effect is further reinforced by Fisher's debt-deflation channel. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2013.01.004
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 16 (2013)
Issue (Month): 2 (April)
Pages: 296-311

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Handle: RePEc:red:issued:12-54

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Related research

Keywords: Financial frictions; Zero lower bound; Fiscal policy;

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Citations

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Cited by:
  1. Giovanni MELINA & Stefania VILLA, 2012. "Fiscal policy and lending relationships," Center for Economic Studies - Discussion papers ces12.06, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  2. Julien Albertini & Arthur Poirier, 2014. "Unemployment benefits extensions at the zero lower bound on nominal interest rate," SFB 649 Discussion Papers SFB649DP2014-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  3. Rossana Merola, 2013. "The role of financial frictions during the crisis: An estimated DSGE model," Working Paper Research 249, National Bank of Belgium.
  4. Javier Andrés & José Emilio Boscá & Javier Ferri, 2011. "Household Leverage and Fiscal Multipliers," Working Papers 1103, International Economics Institute, University of Valencia.
  5. Kühl, Michael, 2014. "The financial accelerator and market-based debt instruments: A role for maturities?," Discussion Papers 08/2014, Deutsche Bundesbank, Research Centre.
  6. repec:spo:wpecon:info:hdl:2441/2g7mhju69b94obeaqlen09s1au is not listed on IDEAS
  7. Flotho, Stefanie, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62028, Verein für Socialpolitik / German Economic Association.
  8. Villa, Stefania, 2013. "Financial frictions in the euro area: a Bayesian assessment," Working Paper Series 1521, European Central Bank.
  9. Christophe Blot & Marion Cochard & Jérôme Creel & Bruno Ducoudre & Danielle Schweisguth & Xavier Timbeau, 2014. "Fiscal consolidation in times of crisis: is the sooner really the better?," Sciences Po publications info:hdl:2441/2g7mhju69b9, Sciences Po.
  10. Stefanie Flotho, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Discussion Paper Series 20, Department of International Economic Policy, University of Freiburg, revised Jun 2012.

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