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On the Recovery Path during a Liquidity Trap: Do Financial Frictions Matter for Fiscal Multipliers?

  • Julio A. CARRILLO

    ()

    (Ghent University)

  • Celine POILLY

    ()

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

This paper investigates the effects of a fiscal stimulus when financial frictions and a liquidity trap are present. These two conditions make a government spending expansion and a reduction in capital income taxes more efficient in stimulating output. In contrast, a reduction in labor income taxes may aggravate the economic conditions. In addition, small implementation delays in government spending may result in big spending multipliers in the short run. All of these results rely partly on the dynamic interaction between inflation and the external finance premium. Lastly, simulations of the ARRA stimulus package predict that the output gains due to the presence of financial frictions may lie between 1.3 % and 2.5 % of GDP.

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Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2010034.

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Length: 56
Date of creation: 02 Sep 2010
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Handle: RePEc:ctl:louvir:2010034
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