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The Road to Recovery: Fiscal Stimulus, Financial Sector Rehabilitation, and Exit from Policy Easing

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  • Zhiwei Zhang

    (Research Department, Hong Kong Monetary Authority)

  • Wenlang Zhang

    (Research Department, Hong Kong Monetary Authority)

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    Abstract

    The worst of the global financial crisis is probably behind us, but the trajectory to recovery may vary widely across economies. Employing a dynamic structural multi-country model with a financial accelerator, this paper studies the role of three important policy actions in economic recovery: fiscal stimulus, financial sector rehabilitation and exit from policy easing. The main finding is that while both fiscal stimulus and financial sector rehabilitation 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 finding suggests that policy priority (of advanced economies in particular) should be on continued financial sector rehabilitation. Moreover, international policy co-ordination is beneficial as it can generate spillovers to regional economies. We also study the effects of over-estimation of the post-crisis potential output by the monetary authorities in advanced economies in their policymaking. We find that this may affect economic recovery in the region through inflationary pressure and the consequent policy tightening.

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    File URL: http://www.hkma.gov.hk/media/eng/publication-and-research/research/working-papers/HKMAWP09_18_full.pdf
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    Bibliographic Info

    Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0918.

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    Length: 22 pages
    Date of creation: Dec 2009
    Date of revision:
    Handle: RePEc:hkg:wpaper:0918

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    Keywords: GIMF model; Financial accelerator; Fiscal stimulus; Financial rehabilitation;

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    1. Svensson, Lars E.O. & Rudebusch , Glenn, 1998. "Policy Rules for Inflation Targeting," Seminar Papers 637, Stockholm University, Institute for International Economic Studies.
    2. 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.).
    3. Mark R. Stone & E. P. Davis, 2004. "Corporate Financial Structure and Financial Stability," IMF Working Papers 04/124, International Monetary Fund.
    4. 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.
    5. Douglas Laxton & Andrew Berg & Philippe D Karam, 2006. "Practical Model-Based Monetary Policy Analysis," IMF Working Papers 06/81, International Monetary Fund.
    6. 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.
    7. 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.
    8. Zhiwei Zhang & Wenlang Zhang & Gaofeng Han, 2009. "How Does the US Credit Crisis Affect the Asia-Pacific Economies? --- Analysis based on a General Equilibrium Model," Working Papers 0912, Hong Kong Monetary Authority.
    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.
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