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Government spending during sudden stop crises

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  • Liu, Siming

Abstract

This paper examines the state-dependent multipliers of government spending in sudden stop economies. First, I provide cross-country evidence that an increase in government spending is more effective in stimulating consumption and appreciating the real exchange rate in sudden stop crises than in normal times. To rationalize this, I then build a small open economy model with a collateral constraint on international borrowing. During a financial crisis, an adverse international shock reduces consumption and lowers the market value of income as collateral. The lowered income, in turn, tightens the financial constraint and sets in a debt-deflation mechanism. In this context, a fiscal expansion appreciates the real exchange rate and drives in capital flows when the financial constraint is binding, thus creating a larger multiplier on private consumption. The difference in multipliers across financial states also depends on the exchange rate environment of a country.

Suggested Citation

  • Liu, Siming, 2022. "Government spending during sudden stop crises," Journal of International Economics, Elsevier, vol. 135(C).
  • Handle: RePEc:eee:inecon:v:135:y:2022:i:c:s0022199622000034
    DOI: 10.1016/j.jinteco.2022.103571
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    1. Benjamin Born & Francesco D’Ascanio & Gernot J. Müller & Johannes Pfeifer, 2021. "Mr. Keynes Meets the Classics: Government Spending and the Real Exchange Rate," ifo Working Paper Series 352, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.

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    More about this item

    Keywords

    State-dependent multipliers; Fisher's debt-deflation; Sudden stop crisis; Downward nominal wage rigidity;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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