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Fiscal multipliers with financial fragmentation risk and interactions with monetary policy

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  • Darracq Pariès, Matthieu
  • Papadopoulou, Niki
  • Müller, Georg

Abstract

We quantify the size of fiscal multipliers under financial fragmentation risk and demonstrate how non-standard monetary policy can support the macroeconomic transmission of fiscal interventions. We employ a DSGE model with financial frictions whereby the interplay of corporate, banks and sovereign solvency risk affect the transmission of fiscal policy. The output multiplier of fiscal expansion is found to be significantly dampened by tighter financial conditions in case households are less certain about implicit and explicit state-guarantees for the banking system, or banks are weakly capitalized and highly exposed to the government sector. In this context, we show that central bank asset purchases or liquidity operations designed to ensure favourable bank funding conditions can restore fiscal multipliers. JEL Classification: E44, E52, E62

Suggested Citation

  • Darracq Pariès, Matthieu & Papadopoulou, Niki & Müller, Georg, 2020. "Fiscal multipliers with financial fragmentation risk and interactions with monetary policy," Working Paper Series 2418, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202418
    Note: 604093
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    References listed on IDEAS

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    2. Drudi, Francesco & Moench, Emanuel & Holthausen, Cornelia & Weber, Pierre-François & Ferrucci, Gianluigi & Setzer, Ralph & Adao, Bernardino & Dées, Stéphane & Alogoskoufis, Spyros & Téllez, Mar Delgad, 2021. "Climate change and monetary policy in the euro area," Occasional Paper Series 271, European Central Bank.
    3. Luca Fanelli & Antonio Marsi, 2021. "Unconventional Monetary Policy in the Euro Area: A Tale of Three Shocks," Working Papers wp1164, Dipartimento Scienze Economiche, Universita' di Bologna.
    4. Fanelli, Luca & Marsi, Antonio, 2022. "Sovereign spreads and unconventional monetary policy in the Euro area: A tale of three shocks," European Economic Review, Elsevier, vol. 150(C).

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    More about this item

    Keywords

    DSGE models; fiscal stabilization; sovereign-bank nexus; sovereign risk;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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